Japanese consumers provide a boost

Emily Nicol
Chris Scicluna

Overview:
While US stocks posted solid gains yesterday (the S&P500 closed up 1.9%), the major Asian equity indices today were mixed. Supported by a notable upside surprise to Q2 GDP (detail below), Japanese stocks advanced, although the 0.4% gain in the Topix was little to get excited about. And with China’s latest price data suggesting a slide back into factory-gate deflation, and the White House postponing a decision to grant licenses for US companies to restart business with Huawei, Chinese stocks fell, with the CSI300 closing down 1.0% on the day and 3.0% on the week.

In bond markets, the Huawei news gave a boost to USTs, with 10Y yields falling back below 1.70% having peaked yesterday above 1.78%. JGBs also made gains, with 10Y yields back below -0.22%, even as the BoJ reduced buying of 3-5Y and 10-25Y bonds and increased purchases of 1-3Y securities to try to arrest the recent flattening of the curve.

Most notable, however, have been events in the euro area bond markets. Following some further poor German trade data, Bunds have also made gains, with 10Y yields down 2.5bps back to -0.59%. And the sell-off in BTPs has accelerated, with 10Y yields currently up about 17bps to 1.70%, as the government coalition appears to have disintegrated. Right-wing populist leader of the League, Matteo Salvini, has upped his call for new elections, evidently deciding that – ahead of difficult decisions on the Budget – the time is right to capitalise on his party’s current elevated poll ratings (now approaching 40%, and roughly 20ppts ahead of its senior coalition partner Five Star). A parliamentary vote of no-confidence seems likely at the end of next week, with a new general election quite possibly to be held in the second half of October, when that challenging Budget should have been finalised.

Looking ahead to the rest of the day, the most notable new economic release comes from the UK, where politics is equally dysfunctional and similarly hijacked by populists. The first estimate of Q2 GDP is bound to be weak – we forecast a very slight contraction – as Brexit weighs more heavily on capex and the impact of precautionary stock-building in Q1 reverses.

Japan:
The first estimate of Japanese Q2 GDP surprised on the upside, reporting growth of 0.4%Q/Q (1.8%Q/Q annualised). Admittedly, this marked a moderation from upwardly revised growth of 0.7%Q/Q in Q1, but nevertheless marked the third consecutive increase to leave output up 1.2%Y/Y, the fastest annual pace for a year and a touch firmer than estimates of Japan’s (admittedly low) potential rate of growth. The year-on-year increase in nominal GDP growth was even firmer in Q2 at 1.6%Y/Y – although this still left output more than ¥40trn short of Prime Minister Abe’s long-held target of a ¥600trn economy.

Growth in the second quarter was underpinned by a pickup in domestic demand. In particular, private consumption accelerated ½ppt to 0.6%Q/Q in Q2, the strongest for two years and accounting for almost three-quarters of GDP growth, supported in part by the extended Golden Week holiday. And perhaps predictably ahead of the scheduled consumption tax hike in October, spending on durable goods was up more than 4%Q/Q having dipped the previous quarter. Private non-residential investment also stepped up, rising for the third consecutive quarter and by a stronger 1½%Q/Q. And with government consumption and public investment rising around 1%Q/Q, final domestic demand boosted quarterly GDP by a substantive 0.7ppt. Against the backdrop of stronger domestic demand, imports were up by more than 1½%Q/Q in Q2. So, with exports having merely moved sideways over the quarter as external demand stagnated, net trade subtracted (a somewhat smaller than expected) 0.3ppt from growth. The negative contribution from private inventories (-0.1ppt) was also less than had been anticipated.

We would expect pent-up demand ahead of the tax hike to continue to support Japan’s expansion in the current quarter, with private consumption and capex set to provide a further boost. Public spending is set to further support growth over coming quarters too. But this might well be negated by the more challenging external environment. And once the sales tax has increased at the start of Q4, GDP will almost certainly go into reverse, with a non-negligible risk that Japan will experience another recession. Our full-year GDP growth forecast this fiscal year and next, of ½%, is below both Japan’s potential rate and the BoJ’s central projection.

With respect to inflation, today’s report saw the implicit GDP deflator move sideways in Q2, leaving it up 0.4%Y/Y, the highest for five quarters. The domestic demand deflator – which provides a better guide to domestic inflationary trends – was also a touch firmer in Q2, but at 0.4%Y/Y it was still the second-lowest reading of the past two years. And this hardly bodes well for the BoJ’s 2% price stability target.

China:
While not unexpected, most striking among the latest Chinese inflation data was the first year-on-year drop in producer prices since summer 2016. PPI dropped 0.3%Y/Y in July, with prices of raw materials down 2.9%Y/Y, the most in three years, and oil prices down more than 8.0%Y/Y. Factory-gate prices of manufactured items were down 0.2%Y/Y. Producer prices of consumer goods were up 0.8%Y/Y, just 0.1ppt softer than the previous three months. But with that figure skewed upwards by food prices (up 2.0%Y/Y on the PPI), prices of durable consumer goods were down on for a sixth successive month on an annual basis, falling 1.2%Y/Y, also the most since 2016. Producer prices of autos were down for a tenth month in a row, falling 0.7%Y/Y.

While factory prices were down on a year ago, consumer price inflation ticked higher, edging up 0.1ppt to 2.8%Y/Y, the highest since February 2018. But there are no prizes for guessing that the increase was due to food prices, which rose 9.1%Y/Y, the most since January 2012 and 0.8ppt higher than in June. Meanwhile, non-food CPI inflation fell for the fourth successive month, down 0.1ppt to 1.3%Y/Y, the lowest rate since June 2016. Core inflation was unchanged at 1.6%Y/Y for a third month, while services inflation was similarly unchanged at a subdued 1.8%Y/Y, matching the lowest since early 2016. With the weaker PPI likely to weigh further on CPI, inflation will be no barrier to further PBoC stimulus.

Euro area:
This morning’s German goods trade report for June highlighted the increasing toll being taken by global events, with the value of exports down 8.0%Y/Y, the most in three years. On a seasonally adjusted basis, exports slipped 0.1%M/M, to leave them down in Q2 by 1.9%Q/Q, the most since the euro crisis in 2012. Imports dropped too, falling for a third consecutive month and by a hefty 2.7%M/M, to be down 2.2%Q/Q. While the goods trade surplus declined almost €4bn in June to €16.8bn, and the services balance deteriorated too, an improved income account saw the current account surplus rise more than €4bn to €20.6bn, a touch above the average of the past twelve months albeit down more than €4bn on its level a year earlier. Looking ahead, there seems every reason to expect the dire export trend to continue, with export orders maintaining a downtrend and surveys suggesting a further deterioration in external demand at the start of Q3.

Like in Germany, France’s industrial sector had a dire end to the second quarter. Today’s figures for June came in much weaker than expected, with the 2.3%M/M drop in IP the steepest for seventeen months. Manufacturing output suffered a similar decline (-2.2%M/M), with weaker production of intermediate goods (-0.3%M/M), capital (-2.8%M/M) and consumer durables (-2.8%M/M). And energy production fell a steeper 3.7%M/M. But the weakness in June was to some extent payback for the strength seen earlier in the quarter. Indeed, energy production was up 3½%Q/Q in Q2. And so, total production eked out a modest increase over the second quarter too (0.3%Q/Q). In contrast, however, manufacturing output fell 0.3%Q/Q in Q2, while construction output fell 1.4%Q/Q. Recent surveys have provided mixed signals about the outlook for the manufacturing sector in Q3. But there is little reason to expect a significant recovery anytime soon. What matters most for the French economy, however, is services, and perhaps reassuringly surveys suggest that conditions in that sector remain broadly stable.

While the main focus in Italy will remain politics, trade figures for June from that country are also due later this morning, along with final inflation figures for July. In addition, beyond the economic data, this evening will see Fitch publish a scheduled review of its Italian sovereign credit rating, which is currently on negative outlook.

UK:
Today will bring the most notable UK economic release of the week in the shape of the first estimate of Q2 GDP, which is bound to report a marked easing in growth from 0.5%Q/Q in Q1. The consensus expectation is for GDP to have moved sideways. But we see a significant chance that output contracted in Q2 for the first time since Q412, with the manufacturing sector in particular a major drag on GDP growth. Meanwhile, services and construction output likely remained subdued. This morning will also bring the monthly output and trade figures for June.

US:
In the US, Friday will bring producer price inflation data for July.

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