Earlier this morning EU leaders agreed to delay Brexit beyond tomorrow’s cliff-edge (see below for the detail). But as they had been fully expected to do so, the market response was minimal. While European government bonds are somewhat weaker this morning (10Y Gilt yields up 1bp to 1.10% and 10Y Bund yields also 1bp higher at about -0.20%) having made gains yesterday on the back of the ECB’s announcements, equities in the region have opened with a mixture of modest gains and losses, and sterling’s little changed too.
Those moves follow a further advance on Wall Street yesterday with the minutes from last month’s FOMC meeting providing no major surprises. The S&P500 closed up 0.35% on another day of light trading volumes – indeed the lowest volume seen this year – while Treasury yields nudged lower – the 10Y yield falling to 2.46% – and the US dollar was little marginally weaker.
In contrast, most key bourses in Asia were flat or weaker today. Losses were led by mainland China where, ahead of tomorrow’s March trade report and while the latest inflation data met market expectations, the CSI300 fell 2.2%. Stocks are down a less pronounced 0.8% in Hong Kong, but in Japan the TOPIX fell less than 0.1% and JGBs inevitably saw little movement following a quiet day for economic data. In Australia the ASX200 fell 0.4% but bond yields were little changed as the country began a five-week countdown to the next federal election on 18 May, which might well lead to a change of government.
In the early hours of this morning in Brussels, EU leaders unsurprisingly kicked the Brexit can down the road once again. Wary of triggering a harmful economic shock, and showing solidarity with Ireland, the EU27 agreed unanimously to extend the Article 50 deadline beyond tomorrow’s cliff-edge.
The new deadline, set for 31 October, was a compromise. While most leaders would have been content to agree to a longer extension of up to a year to give ample time for the UK to sort itself out, not least for domestic reasons French President Macron argued for a shorter extension to end-June. As a sop to Macron, the EU leaders agreed to review progress again on 20-21 June. But while the UK will be expected “to act in a constructive and responsible manner” throughout the extension and refrain from any activity that might disrupt EU policy-making, that date will merely offer a stock-taking opportunity and will not represent a new cliff-edge.
The Halloween deadline is, however, flexible insofar as the UK will be permitted to leave the EU sooner than end-October if, before then, the Withdrawal Agreement is ratified by both sides. And it certainly provides more time for the UK Parliament to agree on a new way forward. But MPs’ room for manoeuvre is constrained by the EU’s insistence that there will be no re-opening of the Withdrawal Agreement, and no negotiations on the future relationship, except on the detail of the (non-binding) Political Declaration.
That, nevertheless, still keeps the door open to MPs agreeing to a softer Brexit than offered by May’s deal. By the same token, the European Council conclusions also acknowledged that the UK could still choose to revoke its Article 50 notice and terminate the Brexit process if it so decides. And the extension also provides just about enough time for the UK to hold a second referendum – or general election – should MPs wish to head down either of those paths. So, a range of possible scenarios exists going forward.
For the time being, we don’t expect an imminent breakthrough in the ongoing talks between the Government and Labour leadership. After all, Labour will be wary to agree to anything that might be reversed in due course by a future Tory Government. And, while Theresa May might well soon wish to hold a new range of indicative votes on certain Brexit options in the House of Commons, events within the Conservative Party will – as ever with Brexit – have a key role to play. Indeed, the results of next month’s local and European Parliament elections (with the UK now compelled to participate in the latter) might well finally prompt May’s departure from Downing Street. But in the absence of a new general election, a change of Conservative leader won’t change the arithmetic in Parliament. So, deadlock might well persist. And a further extension beyond end-October is perfectly feasible.
Of course, persistent Brexit uncertainty continues to have a widespread negative impact on the economy. And this was evident in today’s only UK new data, the RICS house price survey, which once again indicated a subdued housing market and the likelihood that the lack of momentum will continue for some time. For example, according to the RICS survey, new buyer enquiries fell in March for the eighth consecutive month (although the relevant index improved slightly from the drop in February, which was the steepest since May 2008), while agreed sales also continued to fall. And the decline in new supply to the market intensified in March, with the relevant index at its weakest since mid-2016.
It was also not surprising to see the headline net pricing balance still firmly in negative territory, although the slight increase to -24% in March from -27% in February ended a run of eight consecutive months of deterioration. Predictably, London and the South East continued to report the weakest sentiment with respect to house prices, with the relevant net balance in the South East deteriorating to its lowest level for a decade (-61%) . So, with official house prices having fallen in January for the second successive month to leave the annual rate of growth moderating to just 1.7%Y/Y, the softest pace since mid-2013, RICS suggested that continued modest declines in house prices at the national level might be expected over the next couple of quarters.
A quiet day for economic data from the euro area has seen the most notable new reports – final German and French CPI inflation data for March – released already. The German figures confirmed the flash estimates, which meant that, on the EU-harmonised measure, the annual rate dropped 0.3ppt to 1.4%Y/Y, the lowest since last April. The details on the national measure, which saw the headline rate of inflation fall 0.2ppt to 1.3%Y/Y, suggested that energy price inflation reversed the drop of the last few months and rose notably, to 4.2%Y/Y, while food prices and the core components provided negative contributions. The rate for the former halved to only 0.7%Y/Y, while core inflation declined by 0.3ppt to an eleven-month low of 1.1%Y/Y.
In France, likewise, the flash estimate of 1.3%Y/Y on the EU-harmonised measure, down 0.3ppt from February and the lowest for thirteen months, was also confirmed. The CPI rate on the national measure dropped by 0.2ppt to 1.1%Y/Y. And the details echoed the patterns seen in the German data, with food and core inflation easing and energy prices accelerating. So, we fully expect that the final euro area figures, due next week, will confirm the flash estimates of 1.4%Y/Y for headline inflation and – most concerning for the ECB – just 0.8%Y/Y for the core measure. The ECB’s latest survey of professional forecasters is also due for release later this morning. And in the markets, Italy and Spain will sell bonds with a range of maturities.
There were no major surprises from yesterday’s ECB announcements. For example, there was no amendment made to the Governing Council’s forward guidance on interest rates, which are still expected to remain unchanged “at least through the end of 2019”. Its forward guidance on reinvestments of principal payments from maturing securities held under its asset purchase programme was also unchanged, with those proceeds to be reinvested in full “for an extended period of time past the date when it starts raising the key ECB interest rates”. Nevertheless, Draghi was still in dovish mode. And, acknowledging that the risks to the economic outlook remain skewed to the downside, Draghi insisted that all policy options – by implication including rate cuts and a resumption of net asset purchases as well as mere revision to forward guidance – remained on the table should the economic outlook demand further stimulus.
While the previous meeting in March had left some of the detail governing the forthcoming TLTRO-III liquidity operations to be determined, there were no decisions taken on those matters yesterday. However, Draghi stated that the pricing of those operations, to be agreed at a future meeting and presumably in June, would depend on assessments of the effectiveness of the transmission of monetary policy through the banking sector and the economic outlook, including the ECB’s updated economic forecasts. Moreover, consistent with his remarks in Frankfurt last month, Draghi also announced that the Governing Council would also “consider whether the preservation of the favourable implications of negative interest rates for the economy requires the mitigation of their possible side effects, if any, on bank intermediation”.
Admittedly, Draghi’s comments yesterday suggested that the case for action to mitigate the harmful side-effects of negative rates on credit conditions is not yet proven. Nevertheless, at the ECB’s next meeting in June, we would expect the TLTRO-III loans to be priced in a generous manner, with a (likely conditional) negative rate to provide incentives for banks to increase lending. Given the subdued outlook for economic growth and inflation, we would also see strong justification for the ECB’s forward guidance to be revised again, to reflect an expectation that its key interest rates would remain unchanged into 2020. And with the negative deposit rate thus likely to remain lower for longer, the Governing Council will also consider the merits of a tiered interest rate framework, although a more significant deterioration in the economic outlook, and clear evidence of a tightening of credit conditions, might be required before such a policy would be introduced.
Today China released both its CPI and PPI inflation reports for March, with the headline outcomes for both printing exactly in line with market expectations and posing no constraints to further macro policy easing.
Beginning with the CPI, headline prices fell 0.4%M/M – this followed a 1.0%M/M increase in February – but annual inflation still increased 0.8ppt to a five-month high of 2.3%Y/Y. Almost all of the pick-up in annual inflation was driven by food, where prices rose 4.1%Y/Y compared with just 0.7%Y/Y in February. This in turn reflected a sharp lift in prices for both fresh vegetables and pork – the latter impacted by supply constraints due to an outbreak of swine fever. Non-food inflation edged up 0.1ppt to a four-month high of 1.8%Y/Y. However, core inflation (i.e. ex food and energy) was steady at 1.8%Y/Y while service sector inflation edged down 0.1ppt to a 35-month low of 2.0%Y/Y.
Further up the supply chain, the PPI rose a modest 0.1%M/M in March, lifting annual inflation by 0.3ppt to 0.4%Y/Y. Inflation in the mining sector picked up to 4.2%Y/Y from 1.8%Y/Y previously, whereas inflation in the manufacturing sector edged up just 0.1ppt to 0.4%Y/Y. At the PPI level inflation in consumer goods prices also edged up 0.1ppt to 0.5%Y/Y, in part reflecting higher food prices. Prices for durable consumer goods fell 0.7%Y/Y, which was the weakest outcome since May 2018.
In the US, in addition to the latest the weekly claims figures (the last set of which were very encouraging), today will bring PPI figures for March. Higher gasoline prices in March are expected to give headline PPI a boost, while a jump in charges for transportation and warehouse services is also likely after a surprisingly sharp decline in February. So, overall producer prices are expected to rise 0.4%M/M, which might see the annual rate of inflation edge slightly higher to 2.0%Y/Y, while core PPI inflation (excluding food and energy) might be unchanged at 2.5%Y/Y. Meanwhile, in the markets, the Treasury will sell 30Y bonds.
There were no economic reports released in Australia today, but PM Scott Morrison did finally announce that the next federal election will be held on Saturday 18 May. Since the Liberal-National coalition narrowly retained power at the last election held in 2016 – thanks to the support of independent MPs – polling has generally favoured a win for the Labor Party at the upcoming election. Most recently, on a two party preferred basis – whereby, in line with the Lower House electoral system, voters’ preferences are filtered down to the two highest polling candidates – both the latest Newspoll and Essential opinion polls have given the Labor Party a 52-48 lead over the Liberal-National coalition. Both of these surveys were taken after last week’s budget announcement – which included provision for personal tax cuts – so Morrison clearly still has some work to do over the next 5 weeks if he wants to stay in his current post.
The only economic report released in New Zealand today was the Food Price Index for March. In part reflecting a seasonal 3.7%M/M rise in fruit and vegetable prices, the overall index rose 0.5%M/M and was up 1.2%Y/Y.