End game in Rome

Chris Scicluna
Emily Nicol

While US stocks more than gave up their earlier gains as yesterday wore on to leave the S&P500 down 0.3% on the day, futures subsequently turned higher while the main Asian markets posted a mix of gains and losses on a day with little top-tier economic news from the region. Korea’s main indices led the way (KOSPI up 0.9% and KOSDAQ up 2.5%), but Japan’s Topix closed effectively flat on the day. And, with trade-war concerns persisting, China’s CSI300 closed down 0.4%. In Australia, the ASX200 rose almost ½% while ACGBs made gains as construction data significantly disappointed expectations, pointing to downside risks to Q2 GDP (details below). European equities, however, have opened in the red across the board.

Major bond markets, meanwhile, have made further gains today, e.g. with 10Y JGB yields down back to below -0.28% and 10Y UST yields now back below 1.46%, with the 2Y-10Y curve inverted to more than 5bps, and the 3M-10Y spread close to -50bps. With the exception of BTPs, which have given up only a small fraction of yesterday’s big gains as coalition talks near the end game, euro area govvies have opened higher despite a steady German consumer confidence survey (see below).

Euro area:
BTPs rallied further yesterday – 10Y yields dropped 19bps on the day – as the Five Star Movement (M5S) and Democratic Party (PD) seemingly made further strides to reaching a coalition agreement, e.g. with Giuseppe Conte confirmed as the choice of Prime Minister, and the parties both recognising the need to keep the budget deficit within EU limits. But there remain obstacles to be negotiated, not least the role that M5S leader Di Maio might play in any new administration. So, discussions look set to continue this morning, ahead of meetings this afternoon between President Mattarella and the leaders of all main parties, after which he’ll decide whether to invite Conte, M5S and PD to form a new administration or instead simply call a new general election.

After some broadly satisfactory French economic sentiment surveys yesterday, this morning will bring further national confidence indicators, including the Italian ISTAT indices. Last month the headline indices for business and consumer confidence surprisingly rebounded to their highest in nine and six months respectively. But that might simply reflect typical month-to-month volatility in the series. And against the backdrop of increased political uncertainty, Italy’s households and businesses might well indicate greater unease about the economic outlook for the member state where GDP growth was zero on both a quarterly and annual basis in Q2.

Already this morning, however, Germany’s GfK consumer survey beat expectations, with the headline index steady at 9.7, a level which nevertheless matched the lowest in 27 months. Within the detail, the survey flagged a welcome increase in propensity to buy, albeit at a level still down on this time last year. Income expectations deteriorated only slightly. But tallying with the recent marked worsening in business sentiment as highlighted starkly in the August ifo indices, optimism with respect to the economic outlook plunged to the lowest in more than 6½ years. Of course, it’s a lack of external demand rather than domestic household demand that explains Germany’s current economic funk. And while today’s survey suggests that we shouldn’t expect consumer spending suddenly to hit the reverse gear, nor does it suggest large-scale support to growth from the household over the near term. And given the ifo survey, we maintain our forecast of another slight contraction in German GDP in Q3.

Beyond the sentiment surveys, today will bring the euro area’s latest bank lending figures for July. The ECB’s most recent bank lending survey, published last month, reported a tightening of credit standards on loans to enterprises in Q2 related to increased concerns about the economic outlook. Nevertheless, it also reported that loan demand continued to increase across all categories of lending. And so, despite softer GDP growth and weaker economic sentiment, today’s data are expected to report steady consumer and business credit growth at the start of Q3.

Finally, in the markets, Germany will sell 10Y Bunds today.

Against the backdrop of softer consumer spending, the BRC’s latest shop price index suggested that retail price inflation maintained a downward trend in August. In particular, the headline rate fell 0.2ppt to -0.4%Y/Y, the third consecutive negative reading and largest for fourteen months. While food price inflation remained positive, the 1.6%Y/Y increase was the softest since January. And there was steeper pace of decline in non-food inflation, which fell 0.3ppt to -1.5%Y/Y, with a notable drop in clothing and footwear prices (-8.4%Y/Y) as retailers bought forward end of season discounting.

Not least due to intense competition on the High Street, retail price inflation has been significantly weaker than overall consumer price inflation over recent years. Indeed, in July, the headline CPI rate rose back above 2%Y/Y, while the BRC measure of retail price inflation fell 0.2%Y/Y. But while we would expect consumer price inflation to remain considerably higher than the BRC measure of retail price inflation going forward, declining energy prices are likely to more than offset any upwards inflationary pressures from past sterling depreciation, while services inflation is set to remain subdued. As such, we continue to expect the headline CPI rate to fall back below the BoE’s 2% target from August. And despite an anticipated brief boost at the start of the coming year, due to persistently subdued economic growth we expect inflation to fall though the second half of next year, averaging just 1½%Y/Y in H220. And as such, even in the absence of a no-deal Brexit, we suspect that the BoE will ease policy before too long, with a 25bp cut in Bank Rate penciled in for as soon as November.

In Australia, ahead of the Q2 GDP estimate due one week today, focus today was on the latest construction figures for Q2. And these disappointed, with total construction work completed falling 3.8%Q/Q, the fourth consecutive drop and the steepest since Q417. So, compared with a year earlier, total construction work done was down more than 11%Y/Y. There was a larger decline in private sector work done (down 4.7%Q/Q following a 1.7%Q/Q drop in Q1), implying a larger drag on GDP growth than the 0.2ppt seen in Q1. Residential building work done was down a steeper 5.7%Q/Q, 9.6%Y/Y, while non-residential work completed fell more than 6½%Q/Q, leaving it more than 3% lower than a year earlier, both well below the RBA’s recent expectations for Q2. And so, there seems a significant chance that GDP growth will also fall short of the RBA’s implied forecast of 0.8%Q/Q.

A quiet day for top-tier releases brings just the weekly mortgage applications figures. Supply-wise, the Treasury will sell 2Y floating-rate notes and 5Y fixed-rate notes.

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