Morning comment: BoJ OG, Aussie retail sales & May's U-turn

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
Despite a broadly flat session on Wall Street yesterday, moves in Asian equity markets have been positive today, with US equity futures also slightly higher and 10Y UST yields up to 2.51% for the first time in more than a week. Investors appeared to have noted a report which indicated that the US and China are moving closer to a trade deal (albeit with some unresolved issues surrounded implementation and enforcement still to be sorted out). In addition, China’s Caixin services PMI for March backed up the improved showing in the weekend’s official non-manufacturing PMI. So, having already made a strong start to the week, after a late surge China’s CSI300 is up about 1.2%. In Japan, the TOPIX rose a more moderate 0.6%, at the margin perhaps held back by news that Japan’s services PMI had weakened in March (more on this below). But slightly stronger gains were seen in markets in Singapore and South Korea, while Australia’s ASX200 advanced 0.7% and the 10Y ACGB yield increased 3bps to 1.84%, helped by news of much stronger-than-expected growth in retail spending in February, with a record trade surplus also reported for the month (more on this below).

In Europe, meanwhile, the mood is also more upbeat, with government bonds in retreat after yesterday evening’s announcement by Theresa May that she intends to seek a further extension of the Article 50 deadline next week and – in a major U-turn – try to seek a Brexit compromise with the Labour party. While the talks with opposition leader Jeremy Corbyn, which will get under way today, will likely eventually come to nought, MPs will have the opportunity at the start of next week to vote on a range of options. And while next week’s EU summit will not be easy for the PM and will place the Conservative Party under intense strain, May’s manoeuvre certainly reaffirms our expectation that a no-deal Brexit will be avoided. Sterling popped up about 1 cent against the dollar on May’s announcement and it’s taken another leg higher this morning. And 10Y Gilt yields are currently up about 7bps to 1.07% this morning too, with euro area sovereign yields taken higher in the slipstream too (e.g. yields on 10Y Bunds are up more than 3bps to -0.02%).

UK:
So, having yesterday evening announced her intention to reject a no-deal Brexit at the end of next week and instead ask EU leaders for an extension of the Article 50 deadline, in a sharp U-turn from her strategy of almost three years Theresa May will later today meet with Labour leader Jeremy Corbyn to explore whether a possible compromise based on modifications to her negotiated deal can be found. Of course, the offer of these talks has already gone down like a bucket of sick with Conservative backbenchers and the Northern Irish DUP, upon whose support her Government relies for its survival. And, given her recent behaviour, the Prime Minister’s sincerity might reasonably be questioned. So, we certainly don’t expect a new consensus to emerge from today’s meeting. However, following yesterday’s statement, the seemingly inevitable failure of May and Corbyn to agree on a deal today would then mean that a range of options will be presented to MPs to consider at the start of next week, leaving open the door to a new breakthrough.  

Of course, this doesn’t mean that the EU Summit, a week today, will prove to be plain sailing for May. In order to maintain a degree of unity within her Cabinet, her statement yesterday suggested that the PM would hope to limit the extension of the Article 50 deadline to 22 May. However, the EU would be unlikely to acquiesce to that demand, given that the associated risk of a no-deal Brexit immediately ahead of the European Parliament (EP) elections. Instead, therefore, while the door to an orderly Brexit by late May will be left open should MPs legislate a deal in time, the UK will still be compelled to accept a longer extension – perhaps of nine months or more – and thus also pass legislation preparing for participation in the EP elections should that prove necessary. And that could yet prove dynamite for swathes of Conservative MPs, some Cabinet members included. Regardless, May’s proposal certainly reaffirmed our confidence that a no-deal Brexit will be avoided. And while a full range of outcomes remains possible, a softer form of Brexit – involving a form of permanent customs union at a minimum – might seem most likely eventually to emerge. 

Data-wise, today will bring more March UK PMI releases in the form of the closely-watched services and composite indices. The headline services PMI is likely to ease from 51.3 in February, but with the manufacturing output index having risen by almost 3pts to a ten-month high of 55.7, the composite index should also rise, albeit very marginally. So, overall, the PMIs should continue to suggest that the UK economy expanded only very modestly in Q1, likely by no more than 0.1%Q/Q.

Meanwhile, retail price inflation in the UK continued to rise last month, according to the BRC Shop Price index released overnight, with the headline rate up by 0.2ppt to 0.9%Y/Y, the highest in six years. Having in February registered the first positive reading since the end of 2011of 0.2%Y/Y, non-food inflation eased back to zero last month. So, the increase was fully accounted for by higher food inflation, which rose by almost 1.0ppt to 2.5%Y/Y. The BRC attributed this surge to higher global commodity prices as well as bad weather in the UK, which had a negative effect on yields of locally produced vegetables. It is worth noting, however, that the BRC data contrast with official ONS retail price deflators, which suggested that price pressures on the High Street have weakened in recent months. So, overall, we continue to expect that UK consumer price inflation will remain quite stable in the coming months and quarters, with the core CPI rate moving broadly sideways at around 2%Y/Y.

Japan:
Following on from the release of the BoJ’s Tankan survey, today’s service sector and composite PMI reports cast further light on how firms are viewing business conditions. Sadly the headline services business activity index fell a modest 0.3pt to 52.0 in March, thus unwinding some of the improvement registered in February. But this still left the index on average in Q1 at the highest for two years.

Within the detail, after improving substantially last month, the new orders index fell 0.7pt to 53.8, which is nonetheless still the third-highest reading registered since May 2013. However, the business expectations index slumped 2.4pts to an 18-month low of 53.7 and the index measuring outstanding business fell 2.1pts to a 4-month low of 49.9.  Even so, the employment index rose 0.4pt to a 7-month high of 52.1. And in contrast to the downbeat inflation news in the Tankan, the output prices index edged up for a fifth consecutive month by 0.2pt to 52.6 – the highest reading since July last year. In addition, the input price index increased 1.0pt to 55.5. Finally, combined with a decline in the manufacturing output PMI, the composite PMI output index fell 0.3pt to 50.4 in March, which marks the lowest level since September 2016 – an outcome that does not bode especially well for GDP growth in Q1. The composite new orders index fell 0.4pt to 51.8 – still above the January low – and the composite output price index rose 0.2pt to an 8-month high of 52.4.

In other news, the BoJ released its latest estimates of trend output and the output gap. These estimates suggest that trend GDP growth had slowed to 0.66% last year, with a large share of that growth accounted for by increased capex and employment. Even with that investment, the Bank estimated that a shortage of both capital and labour had driven the economy 2.2% above trend at the end of last year – the largest positive output gap recorded since Q292. The BoJ will hope that this gap is maintained and, more importantly, converted into more upward pressure on wages and general consumer prices. It is, however, worth noting that that this estimate contrasts markedly with the Cabinet Office’s measure of the output gap, which it assessed in Q418 to have merely closed. 

China:
Following on from the weekend’s improved official PMI readings, today the Caixin services PMI strongly confirmed an improvement in conditions in the services sector during March. After declining sharply in February – likely influenced by the LNY holiday – the headline index rebounded 3.3pts to a 14-month high of 54.4. Most of the sub-indices also rebounded, with the new orders index rising 2.9pts to 53.8, the new export orders index rising 2.5pts to 53.5 and the future activity index rising 0.5pt to 57.1. The output prices index bucked the trend, falling 0.2pt to 50.6. Combining these results with Monday’s improved results from the manufacturing sector, the headline composite PMI output index increased 2.2pts to a 9-month high of 52.9, leaving it on average in Q1 at 51.5 unchanged from the level in Q4. It remains to be seen whether this level will be sustained in April after volatility associated with the LNY holiday has worked its way out of the data.

Euro area:
Today will bring euro area retail sales figures for February. Thanks to the increase in Germany of 0.9%M/M, sales in the euro area are set to show a modest increase on the month following growth of 1.3%M/M in January to leave them still up about 2¼%Y/Y and suggestive of a quarter of positive growth in private consumption in Q1. The final euro area services and composite PMIs are also due. These seem likely to align closely with the flash estimates, which saw the services PMI fall a fraction to 52.7 and the euro area composite PMI drop 0.6pt to 51.3, just a touch above the multi-year lows reached at the turn of the year. That left the quarterly average at just 51.4, the lowest since Q313 and consistent with GDP growth of just 0.1%Q/Q in Q119. 

US:
The services sector will also be in focus in the US today, with the non-manufacturing ISM and services PMI for March similarly due. In addition, the ADP employment report will cast light on developments in private payrolls last month.   

Australia:
Yesterday evening Australia’s Federal government presented its latest budget, albeit one that may never be implemented if the Government falls at the upcoming General Election. As expected the budget included some modest sweeteners, including increased spending on infrastructure and modest tax cuts for wage and salary earners and small businesses. Even so, the Government still projected an underlying cash surplus of 0.4% of GDP in FY19/20, up from a deficit of 0.2% of GDP in FY18/19. And that surplus is projected to grow to 0.5% of GDP in FY20/21 and 0.8% of GDP in FY21/22, before falling back to 0.4% of GDP in FY22/23. As a result, fiscal policy is unlikely to have much impact on the RBA’s view of future economic developments, at least if this budget is enacted.

Turning to today’s data flow, at the margin the RBA’s concerns about downside risks to growth from the household sector would have been eased by the retail sales report for February, which was much stronger than analysts had predicted. The total value of spending rose 0.8%M/M, marking the largest monthly increase since November 2017. Within the detail, after two soft months, spending at department stores rebounded 3.5%M/M, while spending on household goods and apparel rose more than 1%M/M after being broadly flat in January. Given the strong result, annual growth increased 0.5ppt to 3.2%Y/Y. In addition, this outcome means that average spending over the first two months of Q1 is now 0.5% above the average recorded through Q4 – hardly buoyant, but still leaving Q1 looking much better than following the release of the disappointing January report.

Relatively good news was also seen in the external sector, where a record trade surplus of A$4.80bn was recorded in February – defying market expectations that the surplus would narrow from the very large surplus that had been recorded in January (which was revised down slightly to A$4.35bn from A$4.55bn previously). Exports rose 0.2%M/M, with shipments of non-monetary gold holding close to the very high level reached last month and exports of both non-rural goods and services moving slightly higher this month. As a result, annual growth in exports stood at a sturdy 13.2%Y/Y in February, with non-rural goods exports (excluding gold) up 16.8%Y/Y. Meanwhile, after rebounding last month, imports fell 1.1%M/M in February and were up a comparatively sedate 4.4%Y/Y. Imports of capital goods increased 4.7%Y/Y but imports of consumer goods grew just 0.2%Y/Y, albeit coming off a high base in February last year.

In other news, the CBA services PMI was revised down 0.5pt from its preliminary reading to 49.3 in March, albeit leaving it 0.6pt above the series low that had been reached in February. And after slumping more than 8pts back in January, the more volatile and much longer-running AiG services PMI edged up for a second month, rising 0.3pt to a still-weak 44.8 in March. 

New Zealand:
The CoreLogic QV house price index rose 2.6%Y/Y in March, down slightly from the 3.0%Y/Y increase reported in February. Prices fell 1.5%Y/Y in Auckland and rose just 0.6%Y/Y Christchurch. However, price movements were generally stronger elsewhere in the country (prices in Wellington rose 8.4%Y/Y).

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