Upwards surprise to German CPI ahead of ECB account

Chris Scicluna
Emily Nicol

Overview:
Yesterday’s Congressional testimony by Jay Powell saw the Fed boss underscore the downside risks to the US growth outlook, note risks that weak inflation will persist for longer than the FOMC currently anticipates, and downplay the relevance of last week’s strong payroll report. As such, he reinforced market expectations of a cut in the Fed Funds Rate later this month, with the subsequent release of the minutes of the June FOMC meeting doing nothing to change the prognosis.

So, after US equities advanced yesterday (the S&P500 closed up 0.45%), Asian markets have largely done likewise today. Despite inevitable weakening in the dollar (DXY down below 97 to its lowest level since before Friday’s labour market, and the yen back below 108/$), as well as slightly weaker-than-expected domestic data from the services sector (detail below), Japan’s Topix index rose 0.5%. And for a second day, Korea’s main indices rose more than 1% despite the ongoing trade spat with Japan.

In the bond markets, meanwhile, having rallied immediately following the release of Powell’s testimony, USTs made further gains in Asian time, with 10Y yields now close to 2.03%, about 8bps down from yesterday’s peak (and OIS markets pricing a probability of greater than 50% of three rate cuts by year-end). And JGBs gained across the curve too, with 10Y yields back down to -0.145%, about 2bps down from yesterday’s high.

In Europe, government bonds are very marginally higher even though final German inflation data, released earlier this morning, surprised on the upside, with a 0.2ppt upwards revision to the EU measure (see below for more on this too). All eyes later today will be on the release of the account of the June ECB Governing Council meeting for clues as to whether the next policy meeting in a fortnight is “live” for a rate cut in the euro area. Today’s US CPI inflation data are also bound to be closely scrutinised.

Japan:
Contrasting with the surge in Japanese industrial output in May (up 2.3%M/M according to the preliminary report), as well as stronger household spending that month too, today’s release of May tertiary activity figures fell short of expectations. In particular, services output fell 0.2%M/M, to leave it up just 0.5% compared with a year earlier, the softest annual pace since September. Perhaps surprisingly, despite the extended Golden Week holiday, tourism-related activity declined more than 4%M/M – the steepest drop since the post-consumption tax hike slump five years ago – with hotels reporting a decline of 9%M/M. Wholesale and retail trade was also weaker in May. Admittedly, the weakness in May was likely in part payback for the strength seen at the start of the quarter, with output in the sector rising at the strongest pace for six months in April (0.8%M/M). So, on average so far in the second quarter, tertiary activity was still just above the average level in Q1 (up 0.2% on that basis). Taken together with the pickup in manufacturing output so far in Q2, today’s figures add to evidence that Japan’s economy avoided contraction last quarter.

Euro area:
All eyes today will be on the ECB account from its early-June meeting – when the Governing Council amended its forward guidance to state that rates are expected to remain at their present levels at least through the first half of 2020 – for any further insights into whether a rate cut is likely to be forthcoming at its meeting in two weeks’ time. (While we expect a change of forward guidance this month, we expect the rate cut to be confirmed in September.)

Data-wise, we have already seen the only notable euro area economic data of the day in the form of final June inflation figures from the largest two member states. And these might have reduced marginally the case for a rate cut as soon as this month, with an unusual upwards surprise to today’s German figures, as the headline EU-harmonised inflation rate was revised up from the flash release by 0.2ppt to 1.5%Y/Y, also 0.2ppt higher than the May reading. Admittedly, the preliminary HICP figures had been somewhat at odds with the national inflation numbers. Indeed, the headline rate on the national measure was today confirmed at 1.6%Y/Y, unchanged from the flash estimate and also up 0.2ppt from May. This was due to higher inflation of services (up 0.7ppt to 1.9%Y/Y), as package holidays prices again provided a boost (up 15.2ppts to 6.1%Y/Y) and food (up 0.3ppt to 1.2%Y/Y). In contrast, energy inflation fell 1.7ppts to 2.5%Y/Y. So, today’s release showed that German core inflation rose more than the headline rate, up 0.3ppt to 1.6%Y/Y.

In France, meanwhile, there were no surprises from the final inflation figures, which confirmed the acceleration seen in the preliminary release. In particular, the EU-harmonised and national measure of CPI were confirmed to have risen 0.3ppt in June to 1.4%Y/Y and 1.2%Y/Y respectively. Like in Germany, the pickup in the French national measure principally reflected higher services inflation (up 0.6ppt to 1.2%Y/Y), on the back of higher transport prices (up 3ppts to 1.5%Y/Y). So, while deflation in manufactured goods was unchanged on the month at -0.7%Y/Y, today’s release showed a notable pickup in core inflation in June, by 0.4ppt to 0.9%Y/Y, the highest rate since August.

In the markets, Italy will sell 3Y and 7Y bonds.

UK:
In the UK, after yesterday’s monthly GDP report for May came in marginally stronger than expected, today brought a slight upside surprise from the latest RICS housing market survey too, suggesting some stability had returned at the end of the second quarter. Most notably, the survey suggested a modest increase in buyer enquiries in June for the first time since 2016, while the relevant indicator for new instructions edged into positive territory for the first time in a year. And the survey suggested that sales expectations over the coming three months were broadly stable, while surveyors were more upbeat about the twelve-month horizon. Against the backdrop of rising demand and supply shortages, the survey also signalled a further improvement in the house price balance, up 8pts in June to -1, its highest level since September and more than 25pts above February's trough. While today’s survey suggests, for now, that the worst might be over for the housing market, we wouldn’t get too carried away. Consumer confidence still remains very weak and the persistent Brexit uncertainty will no doubt continue to weigh on the market for some time to come. Indeed, the no-deal Brexit that PM-in-waiting Boris Johnson keeps talking up would provide a massive blow to the sector which, today’s survey suggests is still now merely treading water.

US:
In the US, this afternoon will see Fed Chair Powell repeat his semi-annual monetary policy testimony before the Senate, while the latest CPI figures for June will also attract attention. Downward pressure on energy prices is likely to see the headline CPI rate ease 0.2ppt to 1.6%Y/Y, while the core rate is expected to have moved sideways at 2.0%Y/Y. Tomorrow will also bring weekly jobless claims figures and the Federal monthly budget statement. Supply-wise, the Treasury will sell 30Y bonds.

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