Morning comment: Japan's Q4 rebound disappoints, Germany escapes recession

Chris Scicluna
Emily Nicol

A modestly positive tone continued through the US trading session on Wednesday, thanks to unwavering optimism ahead of today’s US-China trade meetings in Beijing and as the risk of a US government shutdown continued to fade. At the close the S&P500 had posted a further 0.3% gain, while a small upside surprise in the US core CPI for January helped lift the 10Y Treasury yield 2bps to 2.71% and underpinned a slightly firmer US dollar.

Equity markets across Asia, however, have been a mixed bag today with many little changed as investors await any news from the trade talks. One positive sign was provided by a Bloomberg report which, citing the usual “people familiar with the matter”, indicated that President Trump is considering a 60-day extension of his current moratorium on expanding tariff sanctions on China. In Japan, news of a slightly weaker-than-expected rebound in GDP – discussed further below – contributed to leaving the TOPIX effectively unchanged on the day despite a weaker yen. JGB yields nudged very slightly lower. In mainland China this week’s strong stock rally petered out with the CSI300 closing up just 0.15%, even after China’s January trade report proved stronger than market expectations. A mix of small gains and losses were seen across other regional equity markets. In New Zealand bond yields rose further as the market continued to digest the previous day’s surprisingly neutral RBNZ commentary and further details were released on the new arrangements for setting monetary policy from April.

In Europe, data released this morning confirmed that Germany’s economy escaped recession at the end of last year, but only just. And the latest UK housing market survey was the weakest since the global financial crisis. Today’s focus in the US will be December’s retail sales data.  

The focus in Japan today was on the release of the preliminary national accounts for Q4. Analysts had widely expected a rebound in output after a combination of adverse weather events and the Hokkaido earthquake contributed to a sharp contraction in Q3. As it turns out, the preliminary accounts suggest that the rebound was slightly meeker than consensus expectations with real GDP rising a disappointing 0.3%Q/Q (in annualised terms the rebound amounted to 1.4%Q/Q). This modest growth follows a revised contraction of 0.7%Q/Q in Q3 – 0.1ppts larger than estimated previously – although it is worth noting that earlier revisions meant that the level of GDP in Q3 was just 0.03% lower than reported previously i.e. revisions were of negligible significance overall.

Unfortunately, this result means that there was zero GDP growth between Q417 and Q418 – even weaker than the 0.1%Y/Y growth reported in Q3. Across the full calendar year activity was still 0.7% higher than in 2017, but this growth was sharply weaker than the 1.9% lift in output that had occurred during the previous year and at best no faster than the economy’s potential growth rate. Real gross national income (RGNI), which better measures residents’ spending power, also rose 0.3%Q/Q in Q4 with both investment income receipts from the rest of the world and investment income outflows growing at a similar pace (just under 3%Q/Q). However, RGNI was still down 0.8%Y/Y, with investment income outflows growing more than twice as fast as investment income receipts. Before we move on, as always, we need to bear in mind that these preliminary estimates are subject to the possibility of substantial revision. This is especially so in light of the additional investment and private inventory information which will be obtained from the MoF’s quarterly survey of corporations, to be released on 1 March.

Turning to the detail, as expected the rebound in real GDP growth owed solely to stronger domestic demand, while net exports and private inventories detracted from growth – indeed, by more than we had expected. Overall domestic demand rose 0.7%Q/Q in Q4, lifting annual growth by 0.2ppt to 0.5%Y/Y. After declining an unrevised 0.2%Q/Q in Q3, private consumption increased 0.6%Q/Q in Q4 – an outcome that was much as we had expected and sufficient to lift annual growth by 0.2ppt to 0.8%Y/Y. Elsewhere in the accounts, rising labour costs contributed to a 0.7%Q/Q increase in real employee compensation, lifting annual growth to a comparatively strong 2.5%Y/Y from 1.8%Y/Y previously. Clearly the BoJ’s much-desired ‘virtuous cycle’ from income to spending is operating with less force than policymakers would desire. While consumers spent less on non-durable goods in Q4, spending on durables rose a strong 3.3%Q/Q and spending on services rose 1.0%Q/Q – the latter following a 0.8%Q/Q decline in Q3.

Somewhat encouragingly, the other key driver of growth in Q4 was business investment. After declining 2.7%Q/Q in Q3 – 0.1ppts less than estimated previously – the preliminary accounts indicate a 2.4%Q/Q rebound in non-residential investment in Q4. This outcome was sufficient to lift annual growth back up to 3.4%Y/Y from just 1.2%Y/Y previously. And in nominal terms, the share of GDP accounted for by non-residential investment has reached a new high. That said, this estimate is based only on supply side data and, as noted above, is subject to significant revision once the results of the MoF corporate survey are incorporated. Moreover, while capacity constraints provide cause for optimism that growth in investment will continue, the recent slide in business sentiment could weigh on investment in the near-term at least. Meanwhile, residential investment grew 1.1%Q/Q – a second consecutive quarter of positive growth, but leaving output down 2.3%Y/Y nonetheless. News regarding public spending was mixed, with public consumption rising 0.8%Q/Q and 1.4%Y/Y, but public investment declining 1.2%Q/Q and 4.8%Y/Y. Meanwhile private inventories subtracted a preliminary 0.2ppt of GDP growth in Q4, so that final sales increased 0.5%Q/Q – growth that likely won’t be sustained in Q1.

Moving to the external sector, net exports made a disappointing 0.3ppts negative contribution to growth in Q4 – the third consecutive negative contribution and the largest since Q217. In aggregate, exports rose 0.9%Q/Q, but annual growth still slowed to just 0.3%Y/Y from 1.6%Y/Y in Q3. This contrasts with average growth of more than 6%Y/Y during 2017 and the first half of 2018. Exports of goods increased 1.4%Q/Q but exports of services fell a surprising 1.3%Q/Q. After being impacted negatively by natural disasters in Q3, spending by non-residents (i.e. largely tourists) rebounded 6.7%Q/Q, lifting annual growth back to 10%Y/Y. As a result, this implies an especially poor outcome for other services, which have now reported four consecutive quarters of negative growth. Meanwhile, imports rose a much stronger 2.7%Q/Q in Q4, lifting annual growth to 3.6%Y/Y, thus accounting for the overall negative contribution from the sector.

Turning to the current price estimates, nominal GDP was also estimated to have rebounded 0.3%Q/Q in Q4 – again 0.1ppt below market expectations – but was still down a steady 0.3%Y/Y. In rounded terms the implicit GDP deflator fell 0.1%Q/Q and was down 0.3%Y/Y. The domestic demand deflator rose a meagre 0.1%Q/Q, so that annual growth fell 0.1ppt to just 0.5%Y/Y. The consumption deflator was even weaker, being flat in the quarter and up just 0.4%Y/Y. Import prices rose just 0.1%Q/Q in Q4 as the previous positive impulse from energy prices faded. Unfortunately, the export price deflator fell 0.6%Q/Q, indicating that Japan’s terms of trade weakened in Q4.

To conclude, today’s small negative surprise could yet be overturned when the second estimates are released next month. However, at present it seems that even the BoJ’s Board recently heavily-downgraded forecast for real GDP growth in FY18 – a median expectation of 0.9%Y/Y – is likely to prove too optimistic. Indeed, in the absence of positive revisions, and optimistically assuming further growth of 0.5%Q/Q in Q1, GDP growth is on track to come in at just 0.6%Y/Y in FY18 – in line with the forecast of the most pessimistic member of the BoJ’s Board. At the margin today’s data likely provides a setback for the BoJ’s inflation forecast too. That said, at this point the more important uncertainty facing the BoJ is clearly the outlook for the global economy and whether the risks there might prevent already-tight domestic labour market conditions from eventually driving the required upward pressure on inflation at the consumer level.

With trade meetings between senior US and Chinese officials now underway in Beijing, there was always going to be plenty of interest in China’s external trade data for January, notwithstanding the fact that these data are very hard to interpret at this time of year due to the additional volatility caused by significant national holidays in the region. Taken at face value, the report cast the traded goods sector in a much stronger light than had been expected, although it is worth recalling that this follows a very weak report in December. For the record, while China’s trade surplus narrowed to $39.2bn in January from $57.1bn previously, this was a larger surplus than the market had expected. Significant positive surprises were seen on both sides of the ledger, but were largest with regards to exports – these rose an unexpected 9.1%Y/Y in January, in sharp contrast to the 4.4%Y/Y decline reported in December. Imports fell 1.5%Y/Y, but this outcome compared favourably with the 7.6%Y/Y drop reported in December, and even more favourably compared with market expectations.

Looking at the export data by region, exports to the US fell 2.8%Y/Y, representing only a small improvement on the 3.5%Y/Y decline reported in December. By contrast, exports to the EU grew 14.5%Y/Y and exports to Japan grew 5.6%Y/Y – a solid improvement on the respective 0.3%Y/Y and 1.0%Y/Y declines that had occurred in December. Exports to Hong Kong rose 2.5%Y/Y, also recovering from an unusual 26%Y/Y slump in December. Meanwhile, China’s import data also provided some early pointers on the yet-to-be reported export performance of some of its key trading partners. For example, imports from Japan fell 1.1%Y/Y in January, compared with the 11.4%Y/Y decline reported in December (and was down similarly in yen terms). By contrast, China’s imports from the US slumped a huge 41.1%Y/Y – even larger than the 35.8%Y/Y decline reported in December. China’s bilateral surplus with the US stood at $27.3bn in January – the smallest surplus since May 2018, but still $5.4bn wider than the surplus posted in January 2018.

Euro area:
The first estimate of Germany Q4 GDP, released a little while ago, revealed that the euro area’s largest member state just about escaped technical recession at the end last year. Following the decline of 0.2%Q/Q in Q3, economic output was unchanged in Q4, a performance that was a touch softer than the consensus forecast but not wholly unexpected. That left GDP just 0.6% higher than a year earlier, the weakest such rate since Q313.

No expenditure breakdown was provided, but the German statistical office stated that all components of final domestic demand grew on a quarterly basis in Q4, with another strong performance for business investment and government spending, and a modest increase in household spending. With exports and imports rising at broadly the same pace, however, net trade reportedly made no contribution to growth, with the intimation also that stock adjustments subtracted from growth. Given the progress in adjustments in certain sectors over the course of the fourth quarter – most notably in autos – we expect a return to positive German GDP growth in Q1 of 0.3%Q/Q.

Looking ahead to the rest of the morning, the updated estimate of euro area GDP growth in Q4 is strongly expected to align with the flash estimate of 0.2%Q/Q, the same rate as Q3, leaving the annual rate at just 1.2%Y/Y, 1.5ppts lower than a year earlier. Meanwhile, against the backdrop of such subdued GDP growth, euro area employment data for Q4, also due shortly, are highly likely to show a further slowdown in job creation.

The main UK focus today will be the House of Commons debate on Brexit, with proposed amendments aimed at giving MPs greater control over the process to be subsequently voted on. However, with May having promised to come back to Parliament on 26 February with a further update, and parliamentarians to be given another opportunity to influence Brexit policy the following day, today’s debate seems likely to be a rerun of what happened a fortnight ago when MPs failed to agree on anything of substance. Nevertheless, the government might well still lose this evening’s non-binding vote seeking endorsement of its own strategy.

With respect to data, the latest RICS housing market survey provided further evidence of the damaging impact continued Brexit uncertainty is having on the UK economy.  Most notably, the survey suggested that downward pressures on house prices intensified at the start of the year with a net balance of 22% of respondents reporting falling prices in January, the most since 2012. Predictably, the weakness was most evident in London, with a net 72% of survey respondents signalling falling prices, the most since late 2008. And the weakness persisted on both sides of the market with the indicator for new buyer enquiries deteriorating notably in January, to -35%, the lowest reading since June 2008, while the new vendor instructions index fell to -25%. Against this backdrop, transaction levels maintained a downward trend, while the near-term sales expectations indicator dropped to the lowest level since the survey began in 1999. And with the price expectations balance at its lowest level for almost a decade, we see little chance of a notable pickup in house prices over coming quarters.     

In the US, December’s retail sales figures are expected to show only a very modest increase on the month, weighed only in part by lower gasoline prices. January producer price figures, which will also be subdued partly on account of the drop in fuel prices, are also due along with November’s business inventories numbers and the usual weekly jobless claims figures.  

New Zealand:
Today the Minister of Finance and the RBNZ’s Governor signed and released the new Remit and Charter which will come into force with the move to a Monetary Policy Committee (MPC) decision-making structure on 1 April. In summary, the Remit maintains the current operational objective of achieving annual CPI inflation of between 1 and 3% over the medium-term, with a focus on keeping future inflation near 2%, while supporting maximum sustainable employment. In pursing this objective the MPC will continue to discount events that have only transitory effects on inflation, have regard to the efficiency and soundness of the financial system and seek to avoid unnecessary instability in output, interest rates, and the exchange rate. The Charter, which sets the transparency requirements and decision-making procedures for the MPC, states that the MPC will seek a consensus in decision making, but when no consensus is achieved the decision is to be made by a simple majority vote (the Governor will have a casting vote if need be).

Immediately after each meeting the MPC will publish its decision, include a summary record of the meeting that includes an overview of the economic outlook, the risks and policy options discussed, any material differences of view or judgement, and an unattributed record of any vote taken if consensus was note achieved. As at present, four of the seven policy decisions taken each year will be accompanied by a full Monetary Policy Statement. The Charter also contains provisions to govern external communication by MPC members. These provisions are largely designed to ensure that the Governor is the official mouthpiece for expressing the MPC’s decision and to ensure that  comments by other MPC members are respectful of the consensus decision and maintain the confidentially of the views of others individual members of the MPC.

In other news, REINZ – the national real estate association – reported that the number of home sales fell 2.5%Y/Y in January. These data tend to be especially hard to read during the holiday season, so clearer trends are unlikely to emerge until February. Meanwhile the REINZ house price index, which adjusts for the impact of compositional shifts in sales, rose 3.1%Y/Y, down slightly from 3.3%Y/Y last month. Prices fell 2.1%Y/Y in the previously-overheated Auckland market, but recorded an average increase of 8.1%Y/Y elsewhere in the country. Finally, the Food Price Index rose 1.0%M/M in January, but was nonetheless up just 0.8%Y/Y.

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