Morning comment: Euro area flash PMIs, German GDP & Brexit

Chris Scicluna
Emily Nicol

Overview:
Following yesterday’s US holiday, and with Japan’s markets shut today for Labour Thanksgiving Day, the other main Asian equity indices have largely picked up the baton of negativity from European markets yesterday. Most notably, China’s stocks once again posted substantive declines, with the CSI300 down 2.2%, as investor apprehension seemed to grow ahead of next week’s key Buenos Aires Xi-Trump bilateral. Following VP Pence’s tough rhetoric at the APEC summit, making it clear that the Trump administration is in no hurry to end the trade war and calling on China to change its ways, that’s perhaps no surprise. FX markets, however, have been broadly stable, while USTs have reopened a touch lower this morning and BTPs have made further gains despite this week’s very weak take-up by retail investors in the government’s latest bond issue and continued ambiguity from leading coalition politicians on their fiscal policy intentions.

Looking forward to the rest of the day, EU officials will meet in Brussels to discuss the draft Brexit Political Declaration leaked yesterday, with Spanish demands for a veto on future trade arrangements governing Gibraltar a sticking point ahead of Sunday's special summit. And data-wise, today’s most notable release will be the flash euro area PMIs for November, which seem likely to extend the negative trend seen throughout the year.

Euro area:
The steady weakening of economic sentiment indicators in the euro area continued yesterday as the European Commission’s flash estimate of consumer confidence in November took a further step down to its lowest level since March 2017. And today’s flash euro area PMIs for the current month are likewise expected to show a further deterioration.  Having declined 1pt to 53.1 in October, the euro area composite PMI is expected to drop again to a fresh 26-month low raising risks of another quarter of sub-potential GDP growth in Q4. The data are out imminently.

Meanwhile, the final release of German Q3 GDP this morning confirmed that the economy contracted, by 0.2%QQ, for the first time in 3½ years. So, the year-on-year rate of growth also aligned with the flash estimate at 1.1%, almost half the pace recorded in the first two quarters of the year. Within the expenditure breakdown, today’s release showed that exports were the principal drag on growth, with the 0.9%Q/Q decline the steepest since Q412. And with imports up 1.3%Q/Q, net trade subtracted 1ppt from quarterly GDP growth, the most since the start of 2010. Private consumption also provided a modest drag in Q3 (subtracting 0.1ppt from GDP growth) in part due to the impact of the introduction of new car emissions testing which hit sales in September. In contrast, private sector capex remained firm last quarter, with spending on machinery and equipment up 0.8%Q/Q and construction up 0.9%Q/Q, together accounting for 0.2ppt of GDP growth. So, it was mainly due to a notable (perhaps to some extent unplanned) pickup in inventories (contributing 0.7ppt) that Germany’s overall contraction wasn’t steeper. And this hardly bodes well for the extent of the likely rebound in GDP in the fourth quarter. Indeed, while we think another contraction in German GDP in Q4 is unlikely, recent sentiment surveys are hardly consistent with a solid bounce back in activity – indeed, most surveys have signalled a further loss of momentum at the start of the quarter.

UK:
Ahead of tomorrow’s further meeting between Theresa May and Jean-Claude Juncker, and Sunday’s special Summit, today might have been expected to be light on substantive Brexit news, allowing the dust to settle on yesterday’s draft Political Declaration on the future UK-EU relationship to accompany the draft Brexit Withdrawal Treaty released last week. However, EU officials are meeting to discuss the text, with Spain’s Prime Minister Sanchez having signalled its readiness to ‘veto Brexit’ if his demands for a veto on the future trade relationship with Gibraltar are not met. On balance, we do not, however, expect those Spanish objections to prevent the endorsement of the Political Declaration and Withdrawal Agreement on Sunday – unanimity is not required on the Withdrawal Agreement, Spain would still have a veto on the future trade deal if and when it is agreed, and the EU27 might be able to accommodate Spanish demands in a side document. Nevertheless, Gibraltar is undoubtedly a thorny issue, and the minority nature of Spain's government means that it will need to be seen to come away with something that looks more than a meaningless gesture.

Of course, the Political Declaration set out broad aspirations for an “ambitious, broad, deep and flexible partnership” between the UK and EU. Beyond the rhetoric, however, the substance of the document, which would still not be legally binding if and when it is adopted, is hardly encouraging. On the contrary, with the UK having lost most of the substantive arguments with the EU, and sought to fudge several other areas to try to appease the hardcore Conservative Brexiters, the Declaration suggests that the UK is heading for a “blindfold” Brexit, with deliberate uncertainty remaining with respect to the extent of future barriers to trade in goods, and no firm commitments to avoid the imposition of barriers to trade in services, the UK’s dominant economic sector in which it has long had a comparative advantage.

Among other things, the text foresees an “as close as possible” trading relationship on goods, falling short of May’s hopes for a clear commitment for frictionless trade. And the commitment on market access for UK financial services goes no further than a pledge to assess by end-June 2020 whether each party qualifies for the other’s equivalence regime – something that is hardly better than what is available to any other country outside the EU. Other areas in the declaration which appear to have been made deliberately vague or inconclusive to try to satisfy May’s critics include a postponement of any decision on the extent of access to UK waters to EU trawler-men, a reference to technology as a possible (but, in truth, highly unrealistic) solution to avoiding a hard border in Ireland, and a fudge on the transition period, whereby the text allows for an extension of “up to one or two years” beyond end-2020.

But, based on the evidence of yesterday’s debate in the House of Commons, the concessions to the Brexiters might yet prove insufficient to secure ratification by the UK Parliament. With so many Conservative MPs having already pledged to vote against the deal – Buzzfeed News has compiled a list of names suggesting that as many as 88 (more than half) Tory backbenchers are against – the government’s defeat in an initial vote looks all but assured. But, if the Withdrawal Agreement and Political Declaration are indeed voted down at the first time of asking, MPs would still be asked to vote again in some shape or form. And whether at that stage sufficient Tories and Labour MPs eventually change tack to support May’s deal in an attempt to avoid a no-deal Brexit – or the path finally opens to a second referendum – remains very much unclear. So, while sterling was a touch firmer on news of an agreement between the UK and European Commission, volatility seems bound to return over coming weeks.

US:
Black Friday should bring no major economic news in the US with no new top-tier data releases to distract from the shopping.

Australia:
Today saw the release of flash Markit PMI readings in Australia – series that don’t attract much attention, largely due to their short (2½ year) history and the attention placed on the long-running NAB business survey. The news was somewhat better than last month, with the CBA-sponsored composite index rising 0.9pts to 52.9 in November – the best reading since June. All of this month’s improvement was attributable to the services sector where the headline PMI rebounded 0.9pts from last month’s series low to 52.6. The headline manufacturing PMI was steady at 54.5, which is only slightly below the average reading for this series.

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