Factory prices falling

Chris Scicluna
Emily Nicol

Ahead of today’s Congressional testimony from Fed Chair Powell, unsurprisingly Asian financial markets were relatively quiet today. While Chinese and US trade negotiators supposedly had “constructive” talks, China’s CSI300 closed down 0.2% while a downside surprise to the latest domestic price data raised the likelihood of a return to factory-gate deflation over coming months. Likewise, the Topix closed down almost 0.2% as Japanese producer prices went a step further, declining on a year-on-year basis for the first time since 2016 (detail on these inflation data below). Having underperformed earlier this week, however, Korea's main indices made gains today despite signs that the country’s trade spat with Japan won’t be swiftly resolved.

With the risk that Powell might be less dovish after Friday’s labour market report, in the bond markets USTs continued to lose ground, with 10Y yields up about 3bps to above 2.085% for the first time in three weeks. JGBs were similarly lower across the curve, with 10Y yields up a couple of bps to close to -0.13%, similarly the highest since mid-June. And euro area govvies have made losses this morning (e.g. 10Y Bund yields up 3bps to -0.31%) following a big upwards surprise from the latest French industrial production figures, which reported the biggest monthly gain in two years (more on this below too).

That increase in French IP has also given a modest boost to the euro. But forex markets have otherwise been relatively uneventful, with the dollar remaining close to yesterday’s three-week high. The yen briefly moved within a whisker of ¥109/$ for the first time since end-May, however. And, ahead of this morning’s monthly UK GDP data, sterling moved back down close to $1.245 after yesterday evening’s TV debate between the two Conservative candidates to be the next Prime Minister did little more than showcase the lack of substance and slippery evasiveness of the near-certain victor Boris Johnson.

While yesterday’s wage figures provided little cause for optimism that any upwards inflationary impulse might emerge from the labour market anytime soon, today’s goods PPI data also came in weaker than expected, reporting a further moderation in pipeline price pressures in June. In particular, producer prices fell for the second successive month and by 0.5%M/M, to leave them down 0.1%Y/Y, the first year-on-year decline since 2016. Among other things, the impact of the recent yen strength was evident in today’s release, with import prices in yen terms down a hefty 5.4%Y/Y in June following a 1.7%Y/Y drop previously.

Within the detail, the largest price decline (and biggest contribution to the drop in the headline rate) came from petroleum and coal products, down 4.5%M/M, while prices in the nonferrous metals sector were once again down more than 2%M/M. So, with prices of raw and intermediate materials falling in June, it was not particularly surprisingly to see final corporate prices for consumer goods decline for the second successive month to push annual inflation on this measure further into negative territory at -1.3%Y/Y. Prices of durable consumer goods were down 2.7%Y/Y (with prices of imported items down a hefty 6.9%Y/Y in yen terms). And prices of non-durables were down 0.8%Y/Y. All in all, therefore, today’s figures provided further evidence that – notwithstanding the impact of the consumption tax hike due in October – underlying consumer price inflation has now peaked for the year.

China’s latest inflation figures also threw up a downside surprise, with the headline PPI dropping further than expected in June. In particular, producer price inflation fell 0.6ppt – the biggest decline since December – to 0.0%Y/Y (versus the Bloomberg consensus of 0.2%Y/Y), the first non-positive reading since August 2016, which likely sets the scene for a return of overall factory price deflation over coming months. The principal cause of the fall was the accelerated deflation in raw materials prices, down 1.5ppts to -2.1%Y/Y, similarly the weakest rate in almost three years, with iron ore prices down at a double-digit rate and oil and gas prices also lower. But manufactured goods inflation also fell sharply, down 0.5ppt to zero percent. Producer price inflation of consumer goods was unchanged at 0.9%Y/Y for a third month and supported by producer food inflation, similarly unchanged at 2.2%Y/Y. However, the equivalent measure for durable consumer goods slipped to -0.9%Y/Y, the lowest since November 2016, with autos prices down by the same amount.

China’s June consumer price data fully aligned with expectations, with the headline CPI rate unchanged at 2.7%Y/Y, matching May’s fifteen-month high. However, inflation was again boosted by food prices, which rose 8.3%Y/Y, the most since January 2012, with meat and poultry prices up 14.4%Y/Y and fresh fruit prices up more than 40%Y/Y. However, non-food inflation declined 0.2ppt to 1.4%Y/Y, the lowest in almost three years, with services inflation easing slightly again to 1.8%Y/Y, the lowest since February 2016. Prices of transport and communication were down a hefty 1.9%Y/Y, weighed among other things by lower fuel prices. So, core inflation (excluding food and fuel) was unchanged at a three-year low of 1.6%Y/Y. And given subdued demand and an absence of price pressures at the factory gate, underlying consumer price inflation might seem likely to ease further in the second half of the year giving the PBoC scope for further stimulus if it sees fit.

Today will be an eventful day for UK economic news, with a deluge of top-tier releases due including the monthly GDP figures for May, as well as the monthly activity and trade reports for the same month. Following the drop of 0.4%M/M in April, GDP is expected to have risen 0.3%M/M in May. Growth will have been led by a rise in manufacturing output, probably above 2.0%M/M, driven by a rebound in auto production as car plants returned to normal following Brexit-related closures the previous month. Growth in services, however, is expected to have been subdued, at just 0.1%M/M. And having narrowed the prior month, the trade deficit is expected to have widened once again on stronger imports.

Euro area:
Similar to the German release on Monday, the latest French IP figures released this morning indicated a pickup in production in May. But unlike Germany, by recent standards the French industrial sector appears to have been on fire that month, with output rising a much-stronger-than-expected 2.1%M/M, the fastest pace for two years. This left IP up an impressive 4%Y/Y, also the strongest annual rate since 2017.

While energy production posted another strong increase in May (5.2%M/M), construction output was also firmer that month, rising for the first month in three and by 1.9%M/M. Manufacturing output also rose for the first month since February and by a strong 1.6%M/M, supported not least by a rebound in the autos and transport equipment sectors. So, manufacturing production was almost 3½% higher than a year earlier.

Don’t get carried away though. Given the weakness at the start of the quarter, however, the gain in May left French manufacturing output on average in the first two months of Q2 just 0.2% higher than the average in Q1. We also expect it to drop back again in June. But while construction was also down around 2% on the same basis, the surge in energy production left total IP so far in Q2 0.8% higher than the average in Q1.

Ahead of the euro area figures on Friday, Italian industrial production numbers for May are due shortly and are expected to post a modest increase of 0.2 %M/M, which would leave the level of output still down on a year earlier. In the markets, meanwhile, Germany will sell 10Y Bunds.

Of course, most attention today will likely by on the US, with Fed Chair Powell due to testify to the House Financial Services Panel. The minutes from the Fed’s June policy meeting, when the FOMC became significantly more dovish are also due for release, while FOMC voting member Bullard is due to speak publicly.

After yesterday’s NAB survey suggested that Australian businesses were more downbeat in June, today’s Westpac survey suggested that households have become more pessimistic despite recent monetary policy easing, tax cuts passed by Parliament, and signs that the housing market is starting to stabilise. In particular, the headline consumer confidence index fell a notable 4.2pts in July to 96.5, a two-year low. Within the survey, consumers’ expectations for economic conditions over the coming year saw the most significant worsening, with the health of family finances expected to deteriorate over the coming year too. So, it was somewhat surprising to see a modest improvement in attitudes towards spending, with the index related to readiness to spend on major household items more than 2pts higher in July, although this didn’t fully reverse the decline seen in June and left the index still well below its level a year ago. 

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