After a softer performance in US stocks on Friday (the S&P500 closed down 0.6%), Asian markets started this week on the back foot. The mood was not helped by comments from a couple of FOMC members – including the dovish Bullard and Rosengren – that saw markets scale back its expectations for a more aggressive 50bps rate cut later this month, while heightened tensions in the middle east saw the oil price jump. So, while there were no surprises from Japan’s Upper House election at the weekend, which saw Abe comfortably retain his ruling coalition’s majority, the Topix closed ½% lower on the day. The main Chinese CSI 300 was also down 0.7%.
With little domestic data to provide direction today, European markets will largely be in wait-and-see mode ahead of Thursday’s ECB announcement, where we expect the Governing Council to keep policy on hold but provide a strong signal for further easing in September. While Boris Johnson is likely to be confirmed tomorrow as the new leader of the Conservative Party, any meaningful insight into the near-term outlook for Brexit seems unlikely. And in the US, as talks remain ongoing to reach a new agreement on the debt ceiling ahead of the summer recess, focus will be on Friday’s first estimate of Q2 GDP.
There were no major surprises from yesterday’s Upper House election, which saw Abe again emerge as the biggest winner, with the LDP taking 57 of the 124 seats up for grabs and adding the party’s 70 uncontested seats. So taken together with the seats of its coalition partner Komeito (28), Abe’s government maintained a comfortable majority, providing support to proceed with his key economic policies, including most notably the scheduled consumption tax hike in October.
Of course, given that Abe already commands a two-thirds majority in the Lower House, yesterday’s election was always unlikely to alter the economic policy path. But while Abe stated today that the election result also showed that voters wanted a debate on the constitution revision, even with other smaller parties and independents sympathetic to his defence policy ambitions, his ruling coalition fell short of the ‘super-majority’ required to trigger a public referendum on revisions to Japan’s post-war pacifist charter. So, as expected, Sunday’s election result seems unlikely to alter Japan’s current political stance of the ruling government. Economic policy will likely remain the focus, while Abe will continue to merely pay lip-service to defence policy. Moreover, Abe will now become Japan’s longest serving Prime Minister in November this year.
Turning to the data, it should be another relatively quiet day tomorrow with just final wage figures for May and department store sales for June scheduled for release. Of more interest will be Wednesday’s flash PMIs, with the manufacturing index set to remain in contractionary territory, while the services index (the first ever flash release) will likely point to continued steady expansion. Focus at the back end of the week will be on inflation, with services PPI figures for June due Thursday and Tokyo CPI figures for July due Friday. In the markets, a 40Y JGB auction will be conducted tomorrow, followed by a 2Y JGB auction on Thursday.
The main event in the euro area this week, of course, will be the ECB’s latest policy announcement on Thursday. On balance, we expect no substantive policy adjustment this month but a clear signal that further easing is on its way, probably in September.
Certainly, at June’s post-meeting press conference, Mario Draghi had stated that the Governing Council “is determined to act in case of adverse contingencies”. The account of that meeting added that there had been “broad agreement” that the “Governing Council needed to be ready and prepared to ease the monetary policy stance further by adjusting all of its instruments, as appropriate”. But recent comments from Governing Council members have left it uncertain whether they judge that the preconditions for easing policy this month have been met. Indeed, recent economic data – from the euro area and certain other major economies – have been mixed and difficult to interpret with confidence. And as last month’s forward guidance did not explicitly flag the near-term possibility of a rate cut, we think the policymakers will want to wait for September before deciding what to do. Assuming they wait until then, they would also be able to calibrate precisely their policy response with updated economic forecasts that better reflect recent events.
If and when it eases policy this month or in September, moreover, it is highly uncertain what specific form that action will take. As a rate cut of smaller magnitude would likely have little economic impact, we would expect a cut of 20bps in the deposit rate to -0.60%. At the same, to reduce the cost of the negative rate on the banks and thus maintain easy financial conditions and support economic sentiment (particularly in Germany) too, a new tiered interest rate system – such as those long adopted by the BoJ and Danish, Swedish and Swiss National Banks – would also seem likely be announced.
In addition, reflecting the ECB’s readiness to adjust “all of its instruments, as appropriate”, and its assessment that its asset purchases provided more support to growth and inflation over the past few years than negative rates, an increase in the issue limits on the QE programme (from 33% to 50%) might also be announced – possibly this week – as a signal of preparedness to restart net asset purchases again if necessary. Indeed, we would not be surprised if a recommencement of net asset purchases (say, a programme of €45bn per month over nine months) was announced as soon as September if the economic dataflow deteriorated between now and then and/or more substantive downside risks to the economic outlook – e.g. associated with Brexit and/or the US trade wars – looked set to crystallise. Additional net asset purchases would also add credibility to any announcement of a revamped inflation target – such as a symmetrical 2.0%Y/Y target – which a Bloomberg report last week suggested might now be under discussion, and which Draghi would seem bound to be asked about in Thursday’s press conference.
Turning to the data, this week’s calendar will be dominated by economic sentiment survey results for July, kicking off tomorrow with the flash estimate of the Commission’s euro area consumer confidence index for July. Having declined to a near-two year low in December, this indicator ticked a touch higher at the start of the year before oscillating around a broadly sideways trend. And after slipping slightly in June, we expect only modest improvement in the July reading. Wednesday, meanwhile, brings the most notable release of the week in the shape of the flash July PMIs. In June, the euro area services PMI edged up to an eight-month high (53.6). But the equivalent index for manufacturing weakened a little to remain firmly in contractionary territory (47.6). And overall, the average PMIs for Q2 remained underwhelming, with the euro area composite index up just 0.3pt from Q1 to 51.8, the second-lowest level since 2014 implying GDP growth of about 0.2%Q/Q, and the equivalent quarterly PMIs for Germany (52.5) and France (51.3) suggestive of growth at the same pace. Like for consumer confidence, we expect little improvement in the flash PMIs for July.
The French INSEE business climate indices are also due on Wednesday with the similar German ifo indices scheduled for release on Thursday before the ECB announcement, and the Italian ISTAT economic sentiment survey results due on Friday. Beyond the economic survey indices, the ECB’s bank lending data, also due Tuesday, should be consistent with ongoing steady loan growth, led by Germany and France, at the end of Q2. In the markets, meanwhile, Italy will sell a range of regular and index-linked bonds on Friday.
Politics will dominate in the UK this week, with the announcement of the winner of the Conservative leadership election to be made tomorrow morning. Assuming that no major scandals come to light before then, the highly divisive Boris Johnson seems bound to be confirmed as Theresa May’s replacement as head of the ruling party. The following day, Theresa May will take questions in the House of Commons for the last time, after which she will head to Buckingham palace to resign formally as Prime Minister. Johnson should be confirmed as Prime Minister shortly afterwards, allowing him to deliver a first speech from Downing Street later that day, and a first statement to the House of Commons the following day. Later on Thursday, the House of Commons is scheduled to rise for summer recess, after which it is scheduled not to return to work until 3 September. Given the Parliamentary timetable, and with those Conservatives most concerned about a no-deal Brexit temporarily mollified by the vote last week to reduce scope for the Government to force through such a scenario by proroguing Parliament, we assume that a vote of no confidence in the Government will be avoided this week.
Indeed, for a vote of no-confidence in the Government to be held this week, Labour’s Jeremy Corbyn would need to table the appropriate parliamentary motion by Wednesday. If the Government then lost that vote the following day, it would have two further weeks to try to win back the confidence of MPs without which a General Election would then be held in late September. If Corbyn tables his motion on Thursday, the confidence vote would come in early September, with the General Election then likely to be held just a week before the Article 50 deadline of 31 October. Since the anti-no-deal Conservatives would seem unlikely to vote against the Government until all other options to prevent the UK leaving the EU without a deal have been exhausted, however, we do not expect any confidence motion to be tabled until after the recess, and probably not before mid-October if and when all other attempts to block a no-deal Brexit have been exhausted.
Beyond the politics, the UK economic data calendar is extremely light, kicking off tomorrow with the CBI Industrial Trends survey, which will take stock of conditions in the manufacturing sector at the start of Q3. The CBI’s Distributive Trades survey, due Thursday, will likewise give a health-check on the retail and wholesale sectors in July. And between those releases, the UK Finance bank lending figures for June are due on Wednesday. In the bond market, the DMO will sell 10Y Gilts tomorrow.
While discussions in the US remain ongoing to find an agreement in Congress on the debt ceiling before it breaks for summer recess at the end of the week, the key data focus in the economic diary this week will be the first estimate of Q2 GDP on Friday, which is expected to report a moderation in growth of a little more than 1ppt from the rate of 3.1%Q/Q annualised in Q1. Ahead of that, there will be plenty of new data from the housing market, with existing home numbers for June and the FHFA house price indices for May tomorrow, and new home sales figures for June on Wednesday. That day will also bring the preliminary Markit PMIs for July. And ahead of the GDP release the following day, alongside the usual weekly claims numbers, Thursday will give an update on demand at the end of Q2. In particular, advance June data for goods trade and durable goods orders are due that day, as well as wholesale and retail inventory figures for the same month. There will be plenty of regional Fed surveys scattered across the week too, starting with the Chicago Fed national activity indices for June on Monday. In the bond markets, the US Treasury will sell 2Y Notes on Tuesday, 5Y Notes and 2Y FRNs on Wednesday, and 7Y Notes on Thursday.