Morning comment: Japan, euro area & German GDP, UK & US CPI and Brexit

Emily Nicol
Mantas Vanagas

Overview:
The S&P500 rose as much as 1% in early trade on Tuesday as investors responded to the same positive remarks that had lifted Asian bourses off their lows earlier in the day (i.e. regarding the re-opening of a US-China dialogue on trade). Helping to reinforcing sentiment was confirmation that UK PM May had secured the text of a Brexit Withdrawal Agreement to put before her Cabinet today. However, Wall Street gradually erased those gains with energy stocks weighing in particular, with crude oil slumping more than 7% after OPEC further reduced its forecast of demand for OPEC oil in 2019. The tone of Brexit commentary also deteriorated as various comments by UK politicians quickly reminded that the Withdrawal Agreement may not command the support of Parliament, even if it does gain the support of PM May’s Cabinet colleagues. And Italy’s response (or lack thereof) for a new budgetary plan to the Commission also added to the negative outlook.  

With that background it has been a mixed day across Asian markets but with most bourses posting only small gains or losses. With Japan’s GDP report confirming a contraction in GDP that was no worse than market expectations – especially after modest revisions – the TOPIX rose a slight 0.2% after slumping 2.0% on Tuesday. Markets in China, Hong Kong and South Korea were slightly weaker as China’s key October activity reports proved a mixed bag (more on these below). However, Australia’s ASX200 fell 1.7%, adding to the previous day’s 1.8% loss, with the market weighed down by weakness in the commodity sector (energy in particular).

Japan:
The focus in Japan today was on the release of the preliminary national accounts for Q3. Analysts had widely expected a contraction in output, mostly due to a combination of adverse weather and the Hokkaido earthquake. Those expectations proved correct, with the preliminary accounts revealing a contraction of 0.3%Q/Q – exactly in line with market expectations (in annualised terms the decline amounted to 1.2%Q/Q). Despite an upwards revision to growth in Q2, by up 0.1ppt to 0.8%Q/Q and 1.4%Y/Y, with the economy having contracted in two of the past four quarters, annual GDP growth declined to just 0.3%Y/Y. Real gross national income (RGNI), which better measures residents’ spending power, fell an even greater 0.7%Q/Q in Q3 and was down 0.6%Y/Y. The additional weakness owed to both a decline in investment income receipts from the rest of the world and an increase in investment income outflows. Before we move on, as always we need to bear in mind that these preliminary estimates are subject to the possibility of substantial revision. This is especially so in light of the additional capex and inventory information which will be obtained from the MoF’s survey of corporations, to be released on 3 December.

Turning to the detail, as expected the majority of the contraction in real GDP owed to weaker domestic demand, which declined 0.2%Q/Q – sufficient to halve its annual growth to 0.5%Y/Y. After rising an unrevised 0.7%Q/Q in Q2, private consumption posted a less-than-expected decline of 0.1%Q/Q in Q3. While consumers spent more on goods, spending on services fell 0.7%Q/Q in Q3. Meanwhile, the impact of Japan’s natural disasters were evident in spending by non-residents (i.e. largely tourists), which slumped 9.0%Q/Q in Q3. Public consumption, meanwhile, rose 0.2%Q/Q for a second consecutive quarter, however, public investment fell 1.9%Q/Q – a fifth consecutive decline – and was down 3.6%Y/Y. Reflecting a pick-up in housing starts in Q2, residential investment posted a modest lift of 0.6%Q/Q in Q3 – the first growth since Q217 – but was nonetheless down 6.4%Y/Y. After rising an unrevised 3.1%Q/Q in Q2 – the most since Q115 – private non-residential investment non-residential investment fell a modest 0.2%Q/Q in Q3.

Moving to the external sector, as in the previous quarter, net exports made a disappointing – but not unexpected – 0.1ppt negative contribution to growth in Q3. In aggregate, exports fell 1.8%Q/Q, causing annual growth to slow to just 1.1%Y/Y from 5.7%Y/Y previously. Exports of goods fell 1.3%Q/Q but with natural disasters also impacting receipts from tourism, exports of services fell 3.8%Q/Q. Meanwhile, private inventories are presently assumed to have subtracted 0.1ppts from GDP growth in Q3.

Turning to the current price estimates, nominal GDP was also estimated to have contracted 0.3%Q/Q in Q3 – again in line with market expectations – so that annual growth fell to 0.0%Y/Y from 1.4%Y/Y previously. The implicit GDP deflator was thus unchanged in Q3 and down 0.3%Y/Y. The domestic demand deflator rose 0.3%Q/Q, however, lifting annual growth by 0.2ppts to 0.7%Y/Y. Reflecting the firmer CPI readings during the quarter, the consumption deflator rose a somewhat larger 0.5%Q/Q and yet was still up just 0.6%Y/Y. By contrast, propelled by higher energy prices, the import price deflator rose a further 3.0%Q/Q and was up 7.6%Y/Y.

Elsewhere in the accounts, following two quarters of solid growth, compensation of employees rose just 0.1%Q/Q in Q3, causing annual growth to slow to 2.5%Y/Y from 3.4%Y/Y previously. In real terms, compensation fell 0.5%Q/Q but was up 1.5%Y/Y – the latter a little below the average pace recorded over the past three years but still faster than growth in consumer spending. Meanwhile, unit labour costs rose 2.2%Y/Y in Q3. While this might suggest some scope for a firmer pace of inflation, in our view the more likely outcome is that firms’ profits will normalise from the historically high levels that have been reported over the past year or so.

In summary, today’s report provided no great surprises for the market. However, it does confirm that the BoJ’s Board forecast for real GDP growth in FY18 – a median expectation of 1.4%Y/Y – is likely to prove far too optimistic. Indeed, in the absence of positive revisions, FY18 growth would fall short at 1.2%Y/Y even if there were to be a 1.0%Q/Q rebound in GDP in Q4 and further above-trend growth of 0.4%Q/Q in Q119. At the margin this likely provides a setback for the BoJ’s inflation forecast too, although the more important uncertainty facing the BoJ remains just how relatively favourable economic and labour market conditions – as captured by what is already the largest positive output gap in a decade – will come to be translated to pressures on inflation at the consumer level.

Euro area:
A busy day for top-tier releases today include euro area GDP and employment figures for Q3, and IP data for September. While the flash estimate of euro area GDP growth reported a notable slowdown to 0.2%Q/Q (from 0.4%Q/Q in Q2), given the preliminary reading’s proximity to the lower bound of the rounding range and in light of today’s downside surprise to German GDP (see below), there is a risk of a downwards revision.

Certainly, the first estimate of German Q3 GDP this morning came in below expectations, with a drop of 0.2%Q/Q, the lowest reading in 5½ years. This left the annual pace of growth easing to just 1.1%Y/Y, from 2.0%Y/Y previously. While we won’t see an official expenditure breakdown until 23 November, Germany’s statistics agency attributed the decline mainly to net trade. Exports fell, while imports rose again, having posted a notable 1.7%Q/Q increase in Q2. Within domestic demand, household consumption appears to have declined, which would be the first negative reading since the end of 2013, while investment growth reportedly picked up from the 0.5%Q/Q recorded pace in Q2. Overall, the GDP growth seems to have been affected by one-off factors – weakness in the automotive industry caused by a change in emission testing standards as well as logistical disruptions in other sectors due to low water levels of the river Rhine. But while a somewhat stronger pace of growth is on the cards for Q4, the latest survey indicators have maintained the downward trend seen throughout 2018, suggesting only limited, if any, recovery at the end of the year.

Against a backdrop of slowing growth, euro area labour market figures, also due today, might also show a limited rise in employment over the third quarter. Meanwhile, ahead of Friday’s final euro area CPI figures, this morning’s release of October CPI data from France and Spain aligned with the flash estimates – unchanged at 2.5%Y/Y and 2.3%Y/Y respectively. Supply-wise, Germany will sell 30Y bonds.

Turning to Italy, in keeping with the belligerent attitude of the coalition government to the European Commission, the government’s response to the Commission’s calls for a revised fiscal plan came late in the day yesterday and, perhaps unsurprisingly, provided nothing new with respect to the headline numbers. Indeed, Italian Economy Minister Tria confirmed that the government would stick with its decision to embark of higher spending in a bid to kick-start Italy’s economy. So, while defending the government’s excessively optimistic GDP growth forecast of 1.5% next year (yesterday’s IMF article IV provided a growth forecast of 1% in 2019, which we consider generous), he also stuck with the planned surge in the budget deficit forecast, 2.4% of GDP in 2019 (again this is a conservative estimate compared with the Commission and IMF). So, the Commission will likely reiterate its previous criticisms of the plans in an official Opinion by the end of the month, noting again the budgetary plan represented a ‘significant deviation’ from what was required under the EU rules. So the confrontation will likely persist, with a formal disciplinary procedure, which theoretically might eventually lead to the imposition of fines on Italy, likely to be launched in due course. We do not, however, expect financial penalties to be endorsed by the Council of Ministers, at least not until next spring’s European Parliament elections are well out of the way. 

UK:
Focus in the UK today will no doubt remain on Brexit. After EU and UK negotiators yesterday reached agreement on the text of the Withdrawal Agreement, Prime Minister May will hold a Cabinet meeting later today (14.00GMT). While we may see further resignations of Cabinet ministers, reports suggest that key figures – including Dominic Raab – will support the agreement. So, if May succeeds in getting this draft agreement approved, EU ministers later today could well give the green light for a special EU leaders summit later this month, where the deal would hopefully be signed – the EU27 still needs to approve the agreement text, in particular the text relating to the customs union backstop where some countries apparently have some concerns. But the main obstacle will be the UK parliament, where it remains highly uncertain whether May will garner enough support for this Withdrawal Agreement. And if Parliament rejects this deal, then it will be back to the drawing board, with little time left to agree a different approach and with a Government holed below the waterline.

Aside from Brexit-related news, following the further pickup in wage growth in September – with regular labour earnings growth the strongest since 2008 – focus today will be on the latest inflation figures due for release. However, we expect little change last month, with the headline rate set to remain at 2.4%Y/Y in October. Energy inflation will probably pick up as auto fuel prices and electricity and gas tariffs appear to have taken a step up last month, but core inflation should remain at 1.9%Y/Y.

US:
In the US, meanwhile, the main focus tomorrow will be October CPI figures. A modest increase in gasoline prices will help boost the headline index to leave the annual pace increasing for the first time since June, by 0.2ppt to 2.5%Y/Y. The rise in core prices should be a touch softer at 0.2%M/M, to leave the year-on-year rate unchanged at 2.2%.

China:
The main focus in China today was on the release of the remainder of the key activity indicators for October, which proved to be quite a mixed bag. Despite an especially soft manufacturing PMI report, growth in industrial production edged up 0.1ppt to 5.9%Y/Y – better than the steady outcome that markets were expecting – so that year-to-date growth remained stable at 6.4%Y/Y. Growth in power generation slowed to 6.8%Y/Y from 11.0%Y/Y previously. However, growth in both manufacturing and mining activity picked up to 6.1% Y/Y and 3.8%Y/Y respectively, from 5.7%Y/Y and 2.2%Y/Y previously. Turning to the tertiary sector, the news was much less encouraging and more in line with that suggested by the non-manufacturing PMI, which had also weakened in October. Growth in retail spending slowed 0.6ppt to a 5-month low of 8.6%Y/Y – well below the flat outcome that the market had expected. This reduced year-to-date growth by 0.1ppt to 9.2%Y/Y. Given that CPI inflation was steady at 2.5%Y/Y in October, lower volumes appear to explain all of the decline in spending. It is possible that the slowdown reflects volatility associated with the autumn holidays, so next month’s reading will be awaited with particular interest. The biggest ongoing drag on the retail sector remains autos, with spending down 6.4%Y/Y in October.

Meanwhile, growth in fixed asset investment rose 0.3ppts to 5.7%Y/Y in October (measured as usual on a year-to-date basis). This represented a larger improvement than the market had expected and was driven mostly by stronger growth in the state sector. Growth in public spending roses 0.6ppts to 1.8%Y/Y, providing the first real signs of a positive impact from fiscal easing. Growth in private sector investment edged up to 8.8%Y/Y, but has been relatively stable this year. By industry, growth in manufacturing sector investment increased a further 0.4ppts to 9.1%Y/Y, while faster growth was also reported in the agriculture and mining sectors. Growth in closely-watched property development eased 0.2ppts to a 4-month low of 9.9%Y/Y, however.

Summarising the various monthly indicators, Bloomberg’s measure of monthly GDP grew 6.55%Y/Y in October, down marginally from 6.61%Y/Y in September. Even so, the urban unemployment rate remained steady at 4.9%. Looking ahead it still seems likely that growth will slow into year-end and in early 2019, especially with the full force of US tariff policy yet to take effect (even more so if tariff rates on many goods rise to 25% from 10% on 1 January, as is presently scheduled).

Australia:
The main focus in Australia today was on the Wage Price Index for Q3, especially with the RBA’s Board having recently highlighted wage growth as a variable warranting especially close scrutiny. The headline index – which excludes bonuses – rose 0.6%Q/Q, lifting annual growth to a three-year high of 2.3%Y/Y. This outcome was in line with market expectations and boosted slightly by a larger-than-usual 3.5% lift in the national minimum wage on 1 July. Public sector wages rose 0.6%Q/Q, lifting annual growth by 0.1ppts to 2.5%Y/Y. Private sector wages rose 0.5%Q/Q, leaving annual growth steady at 2.1%Y/Y. In the detail, over the past year the strongest growth in private wages was a 3.0%Y/Y lift in both the healthcare and education sectors.

Today’s outcome means that annual growth in regular wages is 0.4ppts above the cyclical low (first reached in 2016) but still 0.9ppts below the average growth recorded over the past two decades. Once bonus payments are included, annual wage growth is somewhat firmer at 2.7%Y/Y – above the headline ex-bonus measure for a third consecutive quarter, and perhaps grounds for expecting regular wage growth to continue to strengthen gradual over the coming year.

In other news, the Westpac consumer confidence survey pointed to an improvement in consumer sentiment over the past month, echoing the improvement seen in the weekly ANZ-Roy Morgan survey. The headline index rose 2.8%M/M to 104.3 in November, moving it a little above its long-term average. The largest contributor to this month’s improvement was substantial pick-up in perception about the 5-year-ahead outlook for the economy. Despite that, respondents indicated that that they were less inclined to buy a major household item.

New Zealand:
The REINZ housing report revealed a 15.5%Y/Y lift in decline in the number of home sales in October – the strongest result for 2½ years and a far cry from the 3.0%Y/Y decline in sales reported in September. The REINZ house price index, which adjusts for the impact of compositional shifts in sales, rose 3.8%Y/Y, down only marginally from 4.0%Y/Y last month. While prices fell 0.4%Y/Y in the previously-overheated Auckland market, they recorded an average increase of 7.9%Y/Y elsewhere in the country.

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