Morning comment: Chinese slowdown & Brexit extension

Chris Scicluna
Emily Nicol
Mantas Vanagas

Somewhat better-than-expected activity readings in the US and Europe – the durable goods orders and IP reports respectively – supported a risk-on tone yesterday. And the confirmation later in the day that the UK’s Parliament was not willing to countenance a ‘no deal’ Brexit reinforced that tone. At the close the S&P500 was up 0.7% - similar to the gain in Europe’s Stoxx600. The positive mood was reflected in tighter credit spreads and firmer commodity prices. However, bond yields were just a smidgen higher – and the US dollar continued weaker – with a softer-than-expected US PPI report supporting the market’s perception that the Fed can remain on hold for some time to come, with the inflation data certainly providing no imperative to tighten policy further.

But after plotting a different course and trading negatively on Wednesday, equity markets across Asia have again failed to be impressed by Wall Street’s rally. Indeed, China’s CSI300 fell 0.7%, while the Shanghai Composite index fell 1.2%, after today’s economic reports pointed to the worst start to the year for China’s industrial sector since 2009 and a lift in the unemployment rate to a 2-year high (more on China’s data below). Markets elsewhere across Asia posted a mix of small gains and losses, with Japan’s TOPIX down 0.2% and the yen slightly weaker as investors continued to await tomorrow’s outcome of the BoJ’s latest Policy Board meeting. While sterling gave up some of yesterday’s late gains overnight, it has firmed again on European market opening, as MPs are bound later today to vote for Theresa May to request an Article 50 extension at next week’s EU summit, with a further vote on the Prime Minister’s deal also set to be held by next Wednesday.

It was no surprise that the House of Commons voted last night to reject a no-deal Brexit. But that rejection went beyond expectations, as MPs expressed their determination to avoid exiting the EU with no deal at any point in the future, not merely at end-March as Theresa May had intended. The result was a further sign of the disintegrating authority and shambolic party management of the Prime Minister, with thirteen ministers (including four from the Cabinet) resisting her whip to contribute to the result, after she had earlier caved-in to demands from hard-line Cabinet MPs to allow a free vote on the unworkable and damaging ‘Malthouse’ amendment.

Given yesterday evening’s result, today MPs will vote on – and are bound to approve – a motion calling on the Government to request an extension of the Article 50 deadline at the EU summit on 21-22 March. Not least as EU leaders wish to avoid the damage of a no-deal Brexit – and also wish to avoid being blamed for such an outcome – we fully expect that extension to be granted next week. But the duration of the extension to be requested remains to be seen.

Before the summit – probably next Wednesday – Theresa May will bring her deal back to Parliament once again for a third meaningful vote (MV3). Despite the PM’s major setbacks in the first two meaningful votes, May will still hope that – with a ‘no deal’ Brexit effectively ruled out – 75 MPs will be willing to reverse their opposition and vote in favour of the deal. If so, she will be able to travel wounded but triumphant to the summit, and simply request a short ‘technical extension’ merely to allow time for the necessary legislation to be adopted and the UK to leave the EU smoothly and enter transition at end-June. If not, humiliated, she will have to request that a lengthy extension, probably to end-2020, be prepared.

Some Brexiter Tories and MPs from the Northern Irish DUP might yet be considered open to persuasion via new legal arguments from the Attorney General Geoffrey Cox to allow them to drop their opposition and vote in favour of the deal next week. And a handful of Labour MPs might also be willing to vote in favour if the PM concedes a greater role to Parliament in influencing subsequent negotiations on the future relationship. However, given the continued vitriol against May’s deal spewing from a number of hardcore Conservative Brexiters in the ERG, it seems unlikely that May will win a majority in MV3 next week. Indeed, many ERG members might be willing to tolerate a lengthy extension, as that would allow scope to unseat Theresa May as Tory leader and Prime Minister by year-end and replace her with someone a whole lot more Brexity. However, if May reduces the deficit in MV3 next week to below 100, we should fully expect her to try again to get the deal over the line in MV4 in the final week of March. And that outcome might be too close to call.

Persisting Brexit uncertainty continues to take its toll on the UK economy. And today’s RICS survey once again highlighted the detrimental effects it is having on the housing market. The major survey indicators pointed to a further slowdown in market activity, with three quarters of respondents attributing the deterioration to Brexit. New vendor instructions continued to decline rapidly underlying problems associated with a lack of available stock. But the drop in new buyer enquiries, a key indicator of demand, was even more pronounced and the largest since the global financial crisis. Against that backdrop, the headline indicator for price growth declined further, by 6ppts to an eight-year low of -28%. Looking ahead, near-term price expectations remained very subdued, perhaps as market participants did not expect a quick resolution to the Brexit stalemate. But longer-term expectations for the coming twelve months were slightly more positive and edged higher for a second consecutive month. We broadly agree with this assessment – with unemployment still low and wage growth having firmed up, if and when we get at least a partial resolution in the Brexit process, housing market sentiment should at least stabilise if not improve markedly.

The focus in China today was on the release of key indicators of domestic activity, for the most part covering the January-February period combined. In summary, these data were consistent with weaker PMI readings already seen this year.

Growth in IP slowed to a 10-year low of 5.3%YTD/Y from 6.2%YTD/Y (and 5.7%Y/Y) in December, which was also 0.3ppt below the Bloomberg consensus and a touch below the previous Y/Y trough in November 2008. Growth in manufacturing output actually edged up 0.1ppt to 5.6%YTD/Y, but overall IP was weighed down by a sharp slowdown in growth in both mining output (up just 0.3%YTD/Y) and power generation (up 6.8%YTD/Y). Double digit declines in output of both motor vehicles and mobile phones weighed on overall growth in the manufacturing sector.

Growth in retail sales slowed to 8.2%YTD/Y from 9.0%YTD/Y (albeit steady from 8.2%Y/Y in December), which was in line with pessimistic market expectations. By contrast, growth in non-rural fixed investment picked up to 6.1%YTD/Y from 5.9%YTD/Y previously, which was also in line with market expectations. The pick-up in capex was driven by state-owned firms, where growth increased to 5.5%YTD/Y from just 1.9%YTD/Y in December. Greater caution was exhibited by private firms, where growth in investment slowed to 7.5%YTD/Y from 8.7%YTD/Y previously. By industry, the involvement of the state was evident in a 7.5%YTD/Y pickup in investment in transportation, up from 3.9%YTD/Y in December. Moreover, growth in investment in the education sector more than doubled to 14.8%YTD/Y. Last year’s slowdown in investment in the utility sector also showed signs of having run its course, with spending down just 1.4%YTD/Y compared with 6.7%YTD/Y in December. Growth in property investment picked up to 11.6%YTD/Y from 9.5%YTD/Y in December, but investment in the manufacturing sector slowed to 5.9%YTD/Y from 9.5%YTD/Y previously.

Finally, the urban unemployment rate rose 0.4ppt to a 2-year high of 5.3% in February – still consistent with this year’s new official target of “around 5.5%”, but a series that will be worth monitoring over coming months (it is possible that the February reading has been impacted by the LNY holiday).

Euro area:
Ahead of tomorrow’s release of February’s final euro area inflation figures, this morning brought the equivalent reports from the largest two member states. In Germany, the EU harmonised figures aligned with the preliminary estimate, showing that prices rose 0.5%M/M in February to leave annual inflation unchanged at 1.7%Y/Y for the third consecutive month. On the national measure, however, there was a modest upwards revision to the flash reading of headline CPI by 0.1ppt to 1.5%Y/Y, up from 1.4%Y/Y in January. Within the detail, energy price inflation accelerated in February (up 0.6ppt to 2.9%Y/Y), with the highest increase recorded for heating oil (14.2%Y/Y), while food price inflation also jumped (up 0.6ppt to 1.4%Y/Y). And despite services inflation having moved sideways at 1.4%Y/Y, core inflation (on the national measure) also edged slightly higher in February, up 0.1ppt to 1.4%Y/Y, a four-month high.

In France, meanwhile, there was a modest upwards revision to the harmonised measure of inflation, by 0.1ppt to 1.6%Y/Y to leave it 0.2ppt higher than January. On the national measure, headline CPI was unrevised at 1.3%Y/Y in February, with an acceleration in energy price inflation (up 2.3ppt to 3.2%Y/Y) and food price inflation (up 0.4ppt to 3.1%Y/Y) in part offset by a moderation in services inflation (down 0.1ppt to 0.9%Y/Y). And with manufactured goods prices continuing to decline on an annual basis, core inflation was unchanged for the fourth consecutive month at a very subdued 0.7%Y/Y.

On balance, despite today’s revisions, when the euro area figures are published on Friday we expect headline CPI to align with the flash estimate, showing a rise of 0.1ppt in February to 1.5%Y/Y. Despite the upwards shift in Germany’s core inflation, not least due to rounding, we anticipate the 0.1ppt drop in the euro area’s core CPI rate to 1%Y/Y to be confirmed too.

In the US, aside from the usual weekly jobless claims figures, this afternoon will bring January new home sales data and February import and export price numbers.


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