Morning comment: Japanese consumption, German IP, Kiwi jobs, Brexit & BoE

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
Wall Street broke a five-day winning streak yesterday, albeit closing with only a small 0.2% loss on lighter-than-usual volume. Treasuries were also little changed, with no direction provided by a light dataflow and a paucity of other important news. While a number of markets remained closed in Asia today – mainland China, Hong Kong and Taiwan – those that were open have provided a mixed performance. Japan’s equity market has been the clear underperformer, with the TOPIX leaving behind an uneventful morning session to eventually decline 0.8% on a busy day for corporate earnings news. An encouraging consumer spending report for December appeared late in the day but provided little support (more on this below), although JGB yields have nudged higher today despite the weaker equity market.

At the other end of the spectrum Australia’s ASX200 rallied a further 1.1% today to its best close since early October, again led by the financials. At the same time, Australia’s 10Y bond yield fell a further 3bps to 2.15% – the lowest close since October 2016 – as investors continued to digest Wednesday’s remarks by RBA Governor Philip Lowe. In a similar vein, New Zealand’s 10Y bond yield fell 7bps to 2.14% – the lowest close since August 2016 – following a Q4 labour market report that fell short of market expectations (more on this below too). The New Zealand dollar also fell by more than 1% in response to this data.

In Europe, ahead of today’s Brexit talks in Brussels between Theresa May and Jean-Claude Juncker, and the BoE’s latest monetary policy announcements and Inflation Report, the dataflow has got off to a soft start with a disappointing German industrial production report. The US dataflow, meanwhile, will remain relatively light today.

Japan:
With the preliminary national accounts for Q4 now just a week away, today the BoJ released its updated Consumption Activity Index for December – as an indicator of private consumption spending, bettered only by the slightly less timely Cabinet Official Synthetic Consumption Index. The BoJ’s index – which is constructed using both demand- and supply-side indicators – increased 0.5%M/M in real terms in December. And with the previous month’s estimated decline halved to 0.3%M/M, this meant that annual growth improved to 1.3%Y/Y from an upwardly-revised 0.8%Y/Y in November. Within the detail a 0.1%M/M decline in spending on services was more than outweighed by a 1.8%M/M rebound in spending on durable goods, while spending on non-durable goods also rose a very solid 1.0%M/M. Meanwhile, the travel-adjusted real index – which conceptually aligns most closely with the national accounts measure of private consumption by removing the net spending of tourists – also rose 0.5%M/M in December following a smaller-than-previously-estimated 0.4%M/M decline in November. As a result, spending on this measure rose 1.0%Q/Q in Q4 – a result that clearly points to the likelihood of a healthy rebound in the national accounts measure of private consumption during the quarter. Further, information on consumer spending will be released in MIC’s household survey tomorrow, albeit this measure has proven to be a less accurate indicator of late. 

UK:
With fifty days to go to Brexit Day on 29 March, Theresa May will today travel to Brussels for what are likely to be fruitless discussions with Commission President Juncker on the Irish border backstop. But a letter sent to her last night by Labour leader Corbyn, offering to back her Withdrawal Agreement as currently drafted subject to amendments to the Political Declaration – including a customs union and close alignment with the single market underpinned by ‘shared institutions’ that would admittedly require her to relax her redlines – makes the pathway a little clearer for May to get some form of Brexit through Parliament with cross-party cooperation if her own party’s hardcore Brexiters and the Northern Irish DUP continue to refuse to back her preferred deal. And with Corbyn also seemingly ditching his party’s agreed policy to keep the option of a second referendum on the table, the probability that the UK will leave the EU with a deal appears now to have risen well above 50%.  

UK monetary policy will also be back in the spotlight today, with the BoE set to announce its latest policy decision at noon (UK time). Given the Brexit mess, there is obviously no chance of a policy change at this meeting: all nine MPC members seem bound to vote to keep Bank Rate at 0.75%. Moreover, at the last monetary policy meeting in December, there were already some signs of concern on the Committee about the UK economic growth outlook – the policy makers judged that GDP most likely slowed in Q4 to our own forecast of 0.2%Q/Q, a weaker pace than the BoE had predicted previously. Since then, UK growth appears to have weakened further, most notably with the PMIs consistent with zero growth at the start of this year. In addition, the external economic environment has deteriorated too, with the euro area economy having lost further momentum while the risks to the outlook in other major economies – not least the US – seem to have skewed to the downside. And while global financial conditions have recovered from their marked deterioration in December, corporate credit spreads in the UK remain elevated relative to their recent norms. All that might suggest that the MPC could make relatively dovish noises today.

Despite the weak economic growth environment, however, the inflation outlook might be considered less conducive to dovishness. The MPC will probably reaffirm its assessment that domestically-generated price pressures continue to build. In particular, the labour market has appeared to tighten further, with the level of vacancies remaining at a series high, and average weekly earnings in November up 3.4%3M/Y, the strongest rate since the global financial crisis. But that higher pay growth is yet to feed through to inflation. In recent months, CPI inflation has been on a downward trajectory and we expect that trend to be maintained for a while yet as lower energy prices push the headline rate below the BoE’s target. Indeed, the oil price assumption used in the BoE’s updated Inflation Report forecast will be significantly lower than the one used in the previous forecasts published in November (which foresaw Brent crude at $78pb in Q419). Among other key variables, sterling has changed insufficiently since then to influence the inflation outlook. But market interest rate expectations have shifted to the downside – having priced in almost three Bank Rate hikes over the three-year forecast horizon three months ago, the OIS curve currently predicts only one and a half hike. 

So, what does that mean precisely for the BoE’s economic forecasts? In terms of GDP, downward revisions are on the cards. Having previously envisaged growth of 1.5%Y/Y in Q418, that estimate will be nudged down. And we think that the GDP forecasts thereafter should really be lowered too. But as long as the BoE maintains its assumption of a smooth Brexit at end-March, its growth projections of 1.7%Y/Y in Q419 and Q420 might well be lowered only slightly. Meanwhile, in accordance with our own view, the MPC will also revise down its inflation forecast over the coming few quarters from above the 2% target to below-target. But, given the downwardly revised interest rate assumption, firmer wage growth, and the likelihood that it will continue to expect GDP to rise above the potential level over coming quarters, the MPC might yet project an above-target inflation rate at the end of the forecast horizon.

As a result, we would not rule out the MPC’s policy statement and minutes carrying a somewhat more hawkish tone than in December. And, certainly, at a minimum, the MPC is likely to repeat its past judgement that, if events pan out in line with its economic forecasts, ongoing tightening of monetary policy at a gradual pace and to a limited extent will be required over the coming few years. Of course, given the current lack of clarity about Brexit, events might pan out in a dramatically different way to that set out in the BoE’s forecasts tomorrow, which would make that policy judgement redundant. 

Euro area:
While yesterday’s German manufacturing data suggested positive growth in orders in Q4 and a strong increase in turnover in December, this morning’s production data were weak across the board. Indeed, total industrial output fell in December for a fourth consecutive month and the tenth month in 2018, dropping 0.4%M/M. On an annual basis, the decline of 3.9%Y/Y was little changed from the previous month, but down more than 10ppts from December 2017 illustrating the sharp turnaround in fortunes for the sector. Among the details, manufacturing output edged slightly higher, by 0.2%M/M, with capital goods output up almost 1.0%M/M. But construction fell more than 4%M/M, representing the weakest reading in almost two years.

Overall, December’s figures left output in Q4 as a whole down by 1.5%3M/3M, only a touch less severe than the drop in Q3, suggesting that industrial production remained an important drag on GDP growth at the end of the year. And while a notable pickup in auto sector orders in December gives grounds for some cautious optimism, surveys point to continued weakness across the bulk of German manufacturing in early 2019 – the output PMI fell back in January to November’s level of 50.3 and the new orders PMI plunged to a particularly weak 44.9, both respectively their lowest readings in more than six years – so we won’t hold our breath for a rebound in output just yet.

December data for Spanish industrial output and Italian retail sales in the same month are also due today. And later this morning, the European Commission will publish updated economic forecasts, which will revise down the outlook for GDP growth in the euro area and various member states. In particular, the Commission’s forecast for Italian growth in 2019 looks set to be revised down to about 0.6%Y/Y compared to the Government’s forecast of 1.0%Y/Y, with implications for the forecast for the Italian government budget deficit. In the markets, France will sell bonds maturing in 2028, 2030 and 2039.   

US:
In the US, the Fed’s consumer credit report for December will be published together with the usual weekly jobless claims numbers. In addition, the Treasury will sell 30-year bonds. 

New Zealand:
The main focus in New Zealand today was on the official labour market report for Q4. Following a surprisingly strong outcome in Q3, today’s reported provided the expected statistical payback in Q4. Indeed, the degree of payback was slightly greater than the market had expected, with employment rising just 0.1%Q/Q (growth in Q3 was revised down 0.1ppt to 1.0%Q/Q) and the unemployment rate rising 0.3ppt to 4.3% (the rate in Q3 was revised up 0.1ppt).

Even so, annual employment growth stood at a sturdy 2.3%Y/Y and the unemployment rate in Q4 was still 0.1ppt lower than in Q2. Moreover, both annual employment growth and the unemployment rate still modestly outperformed the last forecasts published by the RBNZ in the November Monetary Policy Statement. The employer-based QES survey pointed to a 0.3%Q/Q and 1.3%Y/Y lift in filled jobs in Q4, but this survey does not have complete coverage.

Perhaps more disappointing today was the lack of acceleration in labour costs. The overall Labour Cost Index – which measures wage movements across a fixed sample of jobs – rose 0.5%Q/Q in Q4 – the third consecutive such increase. Annual growth picked up 0.1ppt to 1.9%Y/Y, so returning to the cyclical high reported in Q2. The ‘analytical unadjusted index” – which does not adjust for reported changes in labour quality – rose a steady 0.9%Q/Q and 3.3%Y/Y, leaving annual growth unchanged from a year earlier. In the private sector, the headline Labour Cost Index rose 0.5%Q/Q and 2.0%Y/Y, which was 0.1ppt weaker than the expectations of both the market and RBNZ.

In somewhat more positive news, the latest GDT dairy auction resulted in a further 8% rise in the price of whole milk powder – New Zealand’s most important export commodity – to the highest level recorded since the middle of 2018. If sustained the recent improvement will very likely see dairy giant Fonterra raise its forecast payout to farmers, which can be expected to lift sentiment in that sector.

Looking ahead, the RBNZ will release the outcome of its OCR Review and revised Monetary Policy Statement next Wednesday. The domestic news flow has been generally reasonable, with sentiment improving a little in recent months. However, in light of the weaker global news flow and mounting risks that have driven other central banks to take more dovish positions, the RBNZ is likely to restate its already-dovish policy stance, including its preparedness to ease policy further should that be needed. As in Australia, we think that the most likely scenario remains one of unchanged monetary policy throughout 2019. That said, with the RBNZ’s decision-making process due to move to a new MPC structure on 1 April – including three non-RBNZ members that are yet to be named – there is an additional source of uncertainty about the outlook. 

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