UK and Italian political disarray in focus

Chris Scicluna
Emily Nicol

While US and European equities made solid gains yesterday and the mood-music surrounding the trade war appeared somewhat improved again, Asian equities were rather mixed overnight. In China, where the new one-year loan prime rate (LPR) came in at 4.25%, 10bps lower than the former benchmark, the CSI 300 ended the day slightly lower. But despite little domestic news to drive markets, Japan’s Topix closed up 0.8%, while Korea’s KOSPI was more than 1% higher. And with the RBA minutes underscoring the policymakers’ readiness to provide additional policy stimulus if required, among other things reporting discussions on unconventional policy measures, Australia’s ASX 200 rose 1.2%.

In the bond markets, having earlier yesterday risen above 1.62%, 10Y UST yields subsequently slipped back – whether or not due to President Trump’s call on the Fed to cut rates by ‘at least 100bps’ – and are currently a touch below 1.59%. And Euro area govvies have opened marginally higher this morning after weakening yesterday despite the Bundesbank’s flagging of risks that Germany’s economy is slipping into a technical recession. BTPs, however, are a touch weaker ahead of this afternoon’s statement from Giuseppe Conte that is likely bring his tenure as Italian Prime Minister to an end. Meanwhile, Gilts are a touch firmer and sterling has weakened after UK Prime Minister Johnson’s letter to EU Council President Tusk setting out his position on Brexit and the Irish border lacked any substantive proposals and seemed highly likely to antagonise European leaders (see more below).

Boris Johnson’s letter to EU Council President Tusk yesterday evening set out his government’s new position on Brexit and the Irish border. True to form for the Prime Minister, however, it was not a serious effort, offering no constructive proposals for how both sides might meet the obligations of the Good Friday Agreement and maintain an open border while also taking the UK out of the Single Market and Customs Union. Instead, Johnson merely advocated the long-discredited proposal of “alternative arrangements” to the negotiated backstop, with the lack of any detail reflecting the fact that any workable “alternative arrangements” simply don’t – and might never – exist.

Johnson’s letter seems entirely targeted at domestic political consumption. And so, it will not have been well-received well in other EU capitals, not least Dublin. While his strategy might be to try to win new concessions from the EU, such as a time limit on the backstop, to secure a parliamentary majority for a deal, his tactics seem bound to lead to a further erosion of trust and goodwill among European leaders. The overall impression, once again, is that Johnson has no interest in meaningful negotiations, and would care little if the UK left the EU without a deal at end-October.

The data focus in the UK today will be the CBI’s industrial trends survey for August, which is likely to further illustrate the negative impact of continued Brexit uncertainty experienced by UK manufacturers. Indeed, in July, this survey reported that manufacturers’ orders were at their weakest for more than nine years.

Euro area:
Focus in the euro area today will be on Italian politics, with PM Conte set to make a statement to the Senate at 3pm local time. With the League’s Salvini having effectively pulled the plug on his coalition with the Five Star Movement, Conte might seem bound to announce his resignation today. If he doesn’t, however, he’ll surely face defeat in a vote of no confidence in the Senate. What comes thereafter will depend on President Mattarella, who, on the basis of consultations, will have to determine whether to call a new general election for the autumn – which would seem highly likely to result in a new right-wing government led by the League – or instead propose an alternative government to prepare a challenging 2020 Budget capable of winning the support of a majority in the current parliament. If an early election is to be avoided, an agreement will need to be reached between Five Star and the centre-left Democrats, between whom relations over recent years have been dire.

More prosaically, the euro area’s dataflow today will bring construction output figures for June. Following the modest growth seen in construction activity in Germany (0.2%M/M) and France (1.2%M/M) that month, we expect aggregate euro area output to have risen in the sector too. But given the weakness in the previous two months, we still expect construction to have contracted in Q2, albeit reversing only part of the near-2%Q/Q increase in Q1.

There was nothing particularly surprising from today’s minutes from the RBA’s 6 August policy-setting meeting. Nevertheless, they reinforced the message that the policymakers still consider the risks to the growth and inflation outlooks to remain skewed to the downside. And they also underscored that the Reserve Bank will consider further monetary easing if evidence suggests this will be needed to have a hope of hitting its inflation target.

Over the near term at least, of course, additional easing is likely to take the form of further interest rate cuts – indeed, we expect two further 25bp rate cuts before the end of the year to take the Cash Rate to 0.50%. But the minutes also provided insight into the RBA’s considerations of unconventional policy measures implemented by other central banks. RBA Board members understood that the effectiveness of the different measures largely depended upon the specific circumstances facing each economy. But, while it appeared that there was currently no preferred unconventional option for the RBA should it be required, it was also assessed that a package of measures tended to be more effective than individual measures implemented in isolation.

It should be a quiet day in the US with no top-tier data due for release.

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