Morning comment: A rare Japanese CPI upside surprise

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
While yesterday saw government bonds make notable gains on Draghi’s (predictably) dovish announcements, the S&P500 closed up just 0.1% on the day. But the NASDAQ fared better (closing up 0.7%) and the better mood around tech stocks saw more significant gains in Asian markets today, e.g. the Hang Seng and KOSPI rose a little more than 1½%. Japanese equities ended the week on the front foot too, with the TOPIX closing up 0.9%, while the yen depreciated on the improved risk appetite. Despite a significant upside surprise to the latest Tokyo inflation data (see below), however, JGBs made modest gains, with 10Y yields edging down to -0.01%. Meanwhile, sterling appreciated above $1.31 as expectations that a no-deal Brexit will be avoided continued to rise. And while the risk-on mood have seen 10Y UST yields edge back up a few bps having yesterday declined to 2.70%, and European equities have opened higher, further dovish comments this morning from ECB Executive Board member Benoît Cœuré have seen peripheral euro area govvies make additional gains, with yields on 10Y BTPs now down to a six-month low below 2.65% while 10Y Bund yields remain below 0.20%.

Japan:
Against the backdrop of what had appeared to be steadily diminishing price pressures in Japan, today’s advance January CPI for the Tokyo region surprised significantly on the upside to provide a rare piece of good news for the BoJ. Indeed, the seasonally-adjusted headline index rose 0.5%M/M – the largest monthly increase since November 2016 – to leave annual inflation unchanged at 0.4%Y/Y, 0.2ppt higher than the consensus forecast. Meanwhile, the BoJ’s forecast core CPI measure (excluding prices of fresh food) rose 0.2%M/M, boosting the annual inflation rate by 0.2ppt to 1.1%Y/Y, the highest for more than a decade. But the ‘core core’ CPI measure (which excludes prices of energy and all food items, and thus aligns most closely to the core measures followed in other major economies) was the most striking in January, with prices rising for the first month in five and by 0.3%M/M, which, excluding the consumption tax hike, was the strongest monthly reading since October 2010. And this took annual inflation on this measure up 0.1ppt to 0.7%Y/Y, the highest since 1998.

As far as other aggregates are concerned, service sector inflation was also much stronger than expected, rising 0.2ppt to 0.9%Y/Y, also the highest for more than two decades. Meanwhile, excluding fresh food, annual goods inflation also edged up by 0.2ppt to 1.5%Y/Y, supported in large part by higher electricity and gas price inflation, which at 8%Y/Y was the highest for fifteen months. At face value, this report suggests that January’s national CPI will see little change in headline inflation, while core inflation will hold up well. Of course, the impact of the recent decline in oil prices is likely to be more evident at the national level than in the Tokyo report. So, we still expect the BoJ forecast measure of core CPI (excluding prices fresh foods) to edge slightly lower in January, by 0.1ppt to 0.7%Y/Y, and maintain a downward trend over coming quarters, falling to below ½%Y/Y by the end of Q2.

Euro area:
While euro area government bonds rallied and the euro weakened, there were really no major surprises from the ECB yesterday, with Draghi positioning the Governing Council to revisit its rate guidance at the next policy meeting in March. Having already been forced to revise down its GDP forecasts successively in each of the past three quarters, Draghi acknowledged that economic data continue to be weaker than the ECB expected when it last updated its projections in December. And, blaming geopolitical factors more than anything, the Governing Council revised its assessment of the balance of risks to the growth outlook, judging them now to be skewed to the downside.

So, Draghi made clear that we should expect downwards revisions to the ECB’s economic forecasts in March. And while those revisions might again prove too modest to adequately reflect the deterioration of the outlook, they seem likely to be sufficient to prompt the Governing Council to amend its guidance to state the expectation that the key ECB rates are likely “to remain at their present levels at least through 2019” rather than merely “through the summer” as currently defined. That view gained further credence this morning when, in a Bloomberg interview, key Executive Board member (and leading candidate to succeed Draghi as ECB President) Benoît Cœuré stated that it’s too early to say whether rates could be hiked this year and that the forward guidance may have to be adjusted. Of course, the markets have been pricing a delay in the take-off for rates for a while already.

If any further evidence was needed, yesterday’s flash January PMIs offered sufficient justification for a substantive downwards revision to the ECB’s GDP growth forecasts and a delay to any plans to raise rates. The euro area composite PMI declined 0.4pt to 50.7, the lowest since July 2013 and a level consistent with minimal, if any, GDP growth – a sharp contrast with the ECB’s central forecast of growth of 0.5%Q/Q in each of the first three quarters of 2019. While the deterioration in the PMIs was broad-based, thanks to an improved showing in services, Germany’s composite PMI at least managed to rise, up 0.5pt to 52.1, although that still represented the second-lowest reading in more than four years. This morning brings the German Ifo business survey for January, which is expected to show a further deterioration in the headline business climate index in the current month to a 2½-year low, although the PMIs suggest that a modest increase might be in order. The ECB’s latest quarterly survey of professional forecasters is also due for release. In the markets, Italy will sell 2041 inflation-linked bonds

UK:
Yesterday was relatively uneventful in the UK, with no notable new economic data released. But reports that the Northern Irish DUP and some key Tory backbenchers including Graham Brady, chair of the 1922 Committee, have decided to back Theresa May's Brexit deal – subject however to a commitment to include a deadline to the Irish backstop arrangements – gave a further boost to sterling, which rose through $1.31 for the first time since early November. Of course, the EU hardly seems likely to be willing to impose a hard deadline on the backstop – since that would defeat its object as an insurance policy – but an aspiration for a date to conclude a future free trade arrangement and thus terminate the backstop arrangements would seem feasible. Whether that would still pass muster with the DUP, however, is questionable.

Meanwhile, after a day for new UK economic data yesterday, the CBI’s Distributive Trades survey will today give a guide to the strength of demand in January while UK Finance lending data are also due.

US:
In the US, it should be a quiet end to the week for data, with the day’s scheduled releases –including new home sales and preliminary durable goods orders data for December – set to be postponed on account of the shutdown. 

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