Morning comment: ECB, EU summit & Japan spending

Chris Scicluna

As had seemed likely given the earlier price action in Asia, sentiment in US and European markets was broadly upbeat yesterday with the positive impact of improved US-China rhetoric reinforced, among other things, by news that Italy would seek a budget deficit of 2.0% of GDP in FY19, possibly sufficient to appease the European Commission and helping yields on 10Y BTPs fall below 3% for the first time since September. But after being up as much as 1.9% earlier in the day, a still nervous market saw the S&P500 pare much of those gains during the last two hours of trade, leaving the index with a relatively modest 0.5% gain at the close. 10Y yields moved gradually higher over the day to close to 2.91%.

Confirmation that UK PM Theresa May had survived a no confidence motion came just after the US close, and had a limited impact, with sterling largely locking in the gain made throughout the day ahead of the vote (currently about $1.262, a little more than one cent stronger than this time yesterday). But investors were also able to take heart from confirmation that China had resumed purchasing US soybeans. So, during a day that was short of key economic data, Asian markets have generally maintained yesterday’s positive tone, reinforced by a ½% rally in US equity futures. After underperforming yesterday, today’s rally was led by mainland China, with the CSI3300 rising a solid 1.5%. Japan’s TOPIX firmed 0.6%, while gains of between ½-1% were seen across most other key regional bourses.

Attention in Europe now shifts to two set-piece events – the ECB’s latest monetary policy announcements in Frankfurt and the last EU Summit of the year in Brussels. The ECB announcements should see Draghi confirm the end of net asset purchases at the end of the month but also acknowledge the recent further deterioration in the euro area economic outlook, and so send a dovish signal about the likely future path of rates even if the Governing Council’s forward guidance is left unchanged. The Summit will see EU leaders – most of whom now have their own pressing political problems to contend with at home – give Theresa May some non-binding reassurances on the Irish border backstop, which will be insufficient to shift the balance of opinion about the Withdrawal Agreement in the UK Parliament.

On an otherwise quiet day for economic news out of Japan, today the Cabinet Office released its Synthetic Consumption Index for October, providing the most accurate indicator available of how the national accounts measure of private consumption has begun Q4. Encouragingly, the Synthetic Consumption Index reported a 0.3%M/M increase in real consumer spending during the month, following a smaller-than-previously-reported 0.1%M/M decline in spending in September. As a result, spending rose 1.0%Y/Y in October, marking the fastest pace of annual growth reported since February. In addition, the level of spending in October stands 0.2% above the average level recorded through Q3 – a better starting position for Q4 than suggested last week by the BoJ’s Consumption Activity Index. So all up, there appears to be a good prospect that private consumption will at least erase the 0.2%Q/Q contraction that occurred in Q3, and thus contribute to a general rebound in economic activity following the larger-than-expected 0.6%Q/Q decline in GDP reported at the beginning of the week.

Having survived yesterday evening’s confidence vote, Theresa May will be in Brussels today, safe in the knowledge that she now has a twelve-month window free of challenge from within her party, but with her authority further diminished. And having pulled Tuesday’s meaningful Commons vote in the knowledge that she had no hope in hell of winning it, she’ll have her begging bowl out for new reassurances from other EU leaders in the vain hope that might swing the balance of opinion in Parliament in the New Year.

But while May is hoping to gain legally-binding guarantees from leaders about the nature of the controversial ‘backstop’, all they’ll give her will be some non-binding reassurances, e.g. stating that activating the backstop would not be “a desirable outcome” for the EU with the arrangements instead only “an insurance policy”. They will also likely state that the backstop would only apply for a short period, and that there is “full determination” to replace it by end-2020 with alternative arrangements. But, crucially, the leaders will also insist that the Withdrawal Agreement as currently drafted is not open for renegotiation. And so, May will still be on track for defeat when the House of Commons holds its rescheduled meaningful vote, most likely in January. (See our comment issued following last night’s result for further discussion: /ficc-research/recent-blogs/posts/2018-blogs/may-win-fails-to-reduce-brexit-uncertainty )

Euro area:
Today brings the main euro area macroeconomic event of the week with the conclusion of the ECB’s latest policy meeting. Among other things, the ECB is bound to confirm the end of net asset purchases at the end of this month. But the meeting will also give Draghi an opportunity to strike a dovish tone, acknowledging the recent deterioration in the performance of the euro area economy, which should be reflected in the new Eurosystem macroeconomic projections.

Since the last projections were published in September, Q3 GDP surprised significantly on the downside, with euro area growth of just 0.2%Q/Q representing the weakest quarter since 2013 and just half the ECB’s central forecast. Most surveys have suggested a further loss of momentum in Q4 while the global outlook has clouded too. So, while the lower oil price and newly announced French fiscal easing might be expected to provide some support to demand next year, the ECB’s central euro area GDP growth forecasts will need to be revised down from 2.0%, 1.8% and 1.7% in 2018, 2019 and 2020 respectively. Core inflation has also recently come in weaker than policymakers had expected. And despite a pickup in labour cost growth, the ECB ought to revise down its forecasts for headline inflation from 1.7% in each year from 2018 to 2020.

Recognition from Draghi that the economic outlook has deteriorated somewhat, and that the external risks to the outlook are skewed to the downside, should allow him to intimate that the ECB might well not manage to raise rates at all in 2019 even if the Governing Council’s main forward guidance – that rates are expected “to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary” – is left unchanged. Meanwhile, as the ECB has been reviewing its reinvestment policy, greater flexibility might be introduced into the rules governing that process. Draghi might also provide a reminder that maturing proceeds will be reinvested in full until rates have been hiked well above current levels. And Draghi might also signal that, over coming months, the ECB will review options regarding its liquidity provision, not least given the need, by June 2019, to announce new very long-term refinancing operations to mitigate the impact of the scheduled redemptions of loans conducted under the first TLTRO-II programme.

After yesterday’s CPI report for November broadly aligned with consensus expectations, export and import price figures for the same month are due today. Having picked up over recent weeks, the latest weekly claims numbers will also be watched. In the markets, the Treasury will sell 30Y bonds.

New Zealand:
The main focus in New Zealand today was on the release of the Government’s Half-year Economic and Fiscal Update. Following a much higher-than-expected core operating surplus of 1.9% of GDP in FY17/18, a surplus of just 0.6% of GDP is forecast for FY18/19 – half that forecast in the May Budget. This largely reflects timing changes associated with spending that had been programmed to occur in FY17/18, but which will now occur in the current fiscal year. Off that base, the surplus is forecast to rise steadily to 2.3% of GDP in FY22/23, following a trajectory that is similar – but in the near term slightly below – that projected in the Budget. As a result, net core Crown debt is forecast to decline from 20.0% of GDP as at 30 June 2018 to 17.4% of GDP by 30 June 2023. Moreover, including the assets of the New Zealand Superannuation Fund, the Government expects to hold a net positive level of financial assets in FY22/23. Net issuance of NZGBs over the period is forecast to be zero, with issuance only required to fund maturities. Core Crown expenses are forecast to hover at a little over 28% of GDP through-out the forecast period – modestly higher than forecast in the Budget but remaining well below the Government’s self-imposed ceiling of 30% of GDP.

These projections are based on a forecast that the real economy will grow 2.9%Y/Y in FY18/19 and 3.1%Y/Y in FY19/20 – slightly weaker than the optimistic forecasts made in the Budget – before gradually slowing to 2.3%Y/Y by FY22/23. The unemployment rate is forecast to remain close to 4% throughout the forecast period and, remarkably, CPI inflation to forecast to be exactly 2%Y/Y in every year. Finally, it is worth noting that the Treasury’s forecast assumes a gradual monetary policy tightening beginning in FY19/20 but amounting to only around 125bps of tightening in total over the full forecast period – a forecast that is now somewhat closer to the very dovish projections published by the RBNZ.

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