Morning comment: Japan & Aussie data, ECB preview

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
Despite more reports indicating that President Trump is keen to progress a trade deal with China and a generally positive Beige Book from the Fed, Wall Street struggled yesterday with the S&P500 eventually closing down 0.65%. In the bond market, the 10-year Treasury yield fell 3bps to 2.69%, as NY Fed President Williams restated the FOMC’s ‘patience’ mantra, and following the decline in European bond yields that followed the newswire reports suggesting (predictably) that the scale of downward revisions to the ECB’s GDP and inflation forecasts – to be released today – would justify a further LTRO this year (albeit with the detail not necessarily to be announced at today’s Governing Council meeting). It remains to be seen, however, whether the ECB’s forward rate guidance will be revised, although Draghi should certainly be in dovish mode today.

In Asia, meanwhile, a fairly quiet day for local news – ahead of a very busy one tomorrow – has meant that regional bourses have mostly followed Wall Street lower today. In Japan, the TOPIX fell 0.7%, overlooking a better set of consumption data from the BoJ but tallying with the Cabinet Office’s downbeat coincident and leading indicators (see detail below). Meanwhile, China’s CSI300 fell 1.0%, with the loss on the Hang Seng of a similar. But Australia bucked the trend with the ASX200 posting a modest 0.3% gain. In the bond market, JGBs were little changed despite the overnight rally in the US and Europe. In Australia, after yesterday rallying sharply in response to a disappointing GDP report, the bond curve flattened today after a weaker-than-expected January retail spending report took the gloss off much better-than-expected news from the external sector (more on these data below).

Meanwhile, in the FX markets, sterling is little changed despite confirmation from all quarters that the Brexit negotiations are deadlocked – the EU is reportedly calling for the UK to table new ‘acceptable’ proposals within the next 48 hours to allow talks to continue over the weekend and facilitate a deal before Tuesday’s UK parliamentary meaningful vote, which Theresa May currently looks on track to lose.

Japan:
Today’s dataflow out of Japan was very much a mixed bag. For a start, the BoJ released its Consumption Activity Index for January – as an indicator of private consumption spending, bettered only for reliability by the slightly less timely Cabinet Official Synthetic Consumption Index. In contrast to last week’s especially weak retail sales report, the BoJ’s index – which is constructed using both demand- and supply-side indicators – increased 0.2%M/M in real terms in January following an unrevised 0.5%M/M increase in December (the previous month’s reading was revised down 0.2ppt to -0.5%M/M, however). As a result, annual growth improved to a four-month high of 1.4%Y/Y.

Within the detail, after declining over the previous two months, spending on services rebounded 1.3%M/M. However, spending on durable and non-durable goods fell 1.5%M/M and 0.9%M/M respectively, after both had grown solidly in December. Meanwhile, the travel-adjusted real index – which conceptually aligns most closely with the national accounts measure of private consumption by removing the net spending of tourists – rose 0.1%M/M in January and was up 1.2%Y/Y. As a result, spending on this measure presently sits 0.2% above its Q4 average, perhaps providing some cause for hope that private consumption will post positive growth in Q1 (the BoJ’s indicator slightly over-estimated consumption growth in Q4, at least on current numbers). Further, information on consumer spending will be released in MIC’s household survey tomorrow, albeit this measure has proven to be a much less accurate indicator of late. The Cabinet Official Synthetic Consumption Index will likely come available sometime next week.

The BoJ’s consumption figures aside, most economic indicators out of Japan since the start of the year have disappointed. As such, it was perhaps not surprising to see that the Cabinet Office’s measure of business conditions – an aggregate index of key cyclical indicators that represent differing activities of the economy such as production, retail, employment, and corporate profitability – signalled a notable worsening of economic activity in January. In particular, the composite coincident index declined for the third consecutive month and by 2.7pts to 97.9, its lowest reading since June 2013, while the composite leading index was the lowest since mid-2016. And with the coincident diffusion index – used to determine turning points in the cycle – at its weakest level since December 2015/January 2016 (GDP declined by 0.4%Q/Q in Q415) and falling well into contractionary territory, the indicator was today assessed by the Cabinet Office to be signalling a possible turning point to the worse.

Euro area:
Today brings the main event of the week in the euro area with the conclusion of the ECB policy meeting. There are three main things to watch: the updated staff economic forecasts, which are bound to bring downwards revisions from the current set; possible amendments to the forward guidance on rates; and news on plans to offer new longer-term liquidity operations.

Certainly, downgrades to the ECB’s economic forecasts are inevitable. As soon as they were published in December, the current set of projections already looked woefully optimistic. And at the policy meeting in January, the Governing Council acknowledged that subsequent economic data had been weaker than it expected, and also revised its assessment of the risks to the outlook, judging them to be skewed to the downside. While they were not quite so unrealistic, the inflation forecasts also looked too strong. Nevertheless, comments last week from Irish Central Bank Governor and ECB Chief Economist-designate Philip Lane suggested that the December projections would need only “reasonably small adjustments”, a sentiment tallying with remarks of other Governing Council members. And it would be out of character for the ECB to make marked downward revisions.

So, we expect the ECB today to revise down its GDP forecast by 0.3ppt in 2019 to 1.4%Y/Y and by 0.2ppt in 2020 to 1.5%Y/Y, while leaving its 2021 projection unchanged at 1.5%Y/Y. We also anticipate the ECB’s headline inflation forecast to be revised lower by 0.1ppt a year to 1.5%Y/Y in 2019, 1.6%Y/Y in 2020 and 1.7%Y/Y in 2021, with the core inflation forecast also perhaps nudged down by 0.1ppt across the horizon. In our opinion, those forecasts will still be too strong, and will require further downwards revisions when they are updated again in June.

The weaker outlook for GDP growth and inflation would, in our opinion, justify a revision to the ECB’s policy guidance, which states that the key interest rates are expected “to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary”. A plausible amendment would be the deletion of the words “at least through the summer of 2019 and in any case” from the existing commitment. But a majority of policy members might not be ready to go quite so far this time around. Certainly, many members are concerned about possible negative side effects on banking sector conditions from maintaining negative rates for a prolonged period. So, they could be reluctant at this stage to rule out the possibility of a rate hike this year, and the current forward rate guidance might well remain in place until June. Nevertheless, Draghi might well use his press conference to inject additional dovishness even if the forward guidance is left intact for now.

Finally, as suggested by yesterday’s Bloomberg report, this meeting will see the Governing Council agree that it needs to respond to the redemption of more than €700bn of outstanding TLTROs-II (Targeted Longer-term Refinancing Operations) funds, due from the middle of next year, which represents a potential future “cliff edge” to banking sector liquidity. So, we expect it to announce its intention to offer a new round of very long-term liquidity operations. But we doubt that there will be a conclusive discussion on the all-important conditions to be attached or the precise timing. Instead, those details – which we eventually expect to be less generous than those applied to the TLTROs-II (e.g. in terms of maturity, interest rate charged, and/or total funds available) – will likely be announced following one of the subsequent two meetings.

Data-wise, this morning will bring a revised estimate of euro area GDP in Q4, along with the first expenditure breakdown, which should suggest that growth was led by domestic demand. While Tuesday’s updated Italian figures saw the extent of the decline in Q4 revised down, we expect euro area GDP growth to be confirmed at 0.2%Q/Q and 1.2%Y/Y. Thursday will also bring revised euro area employment figures for Q4, which will include a country breakdown.

UK:
Ahead of next Tuesday’s meaningful vote in the UK parliament, all reports suggest that the Brexit negotiations remain deadlocked. The UK side has reportedly been given 48 hours to come up with new ‘acceptable’ proposals on the Irish backstop to allow talks to be extended through the weekend and open up the possibility of a bilateral between May and Juncker on Monday to reach a new deal. UK Attorney-General Geoffrey Cox, who has played a key role in this latest round of talks, will answer questions in the House of Commons on the state of play in the negotiations this morning.

Cox’s comments this morning should be watched - assuming May manages to secure a new agreement at the start of next week, a key test for MPs from the Northern Irish DUP and many Brexiter Conservatives from the ERG will be whether it allows Cox to change his previous legal opinion that, if the Withdrawal Agreement is approved, the UK could be trapped “indefinitely” within the backstop. But the current newsflow only serves to strengthen our expectation that any assurance provided by Cox will not prove satisfactory to a significant number of those right-wing Brexiters. Moreover, Theresa May’s efforts to persuade opposition MPs from Leave-voting constituencies to back her deal – including the new £1.6bn “Stronger Towns Fund” for “left-behind towns” and arrangements for Parliament to consider matching future EU legislation on workers’ rights – appear to have been sufficient to persuade perhaps no more than a dozen Labour MPs to back her deal. As such, we attach a probability of some way less than 50% that May will win the support of a majority of MPs for her deal next week, an outcome that will, of course, lead to an extension of the Article 50 deadline.

US:
Ahead of tomorrow’s US payrolls data, today brings the usual weekly claims data along with Q4 productivity and labour cost figures, the flow of funds for the same quarter, and January consumer credit numbers.

Australia:
Following on from yesterday’s disappointing national accounts, which included another soft quarter for consumer spending, the RBA’s concerns about downside risks to growth from the household sector would not have been eased by today’s retail sales report for January. The total value of spending rose just 0.1%M/M, marking a much weaker-than-expected rebound from an unrevised 0.4%M/M decline in December. Within the detail softer spending at department stores and on apparel, together with a flat month for household goods, was only slightly outweighed by increased spending on other items. Given a relatively low base, annual growth slowed just 0.1ppt to 2.7%Y/Y. However, the level of spending in January was essentially unchanged from that recorded on average in Q4. As a result, a solid increase in spending will be required in February to avoid the prospect of a very soft outcome for Q1.

Much better news was seen in the external sector, where a very large trade surplus of A$4.55bn was recorded in January – a huge A$1.8bn above market expectations and just below the record surplus achieved in December 2016. Exports rose 5.0%M/M, with about two-thirds of that growth due to very substantial shipments of non-monetary gold (this varies greatly from month to month). Annual growth in growth in exports stood at a sturdy 15.9%Y/Y, with rural exports up 24.5%Y/Y and non-rural exports (excluding gold) up 18.8%Y/Y. Meanwhile, after declining sharply last month, imports rebounded 3.3%M/M and were up 6.3%Y/Y. Imports of capital goods rebounded 12.4%M/M and were up 7.5%Y/Y, while shipments of consumer goods rebounded 5.8%Q/Q and were up 5.8%Y/Y. Finally, it is worth noting that the substantial improvement in the trade balance since the middle of last year largely reflects developments in relative prices (i.e. the terms of trade) rather than relative volumes (indeed, as reported yesterday, net exports volumes fell in Q4).

New Zealand:
The countdown to the release of New Zealand’s national accounts, on 21 March, continued today with information released on the performance of the wholesale sector during Q4. The value of sales edged down 0.1%Q/Q, marking the first decline for three years, so that annual growth slowed to 4.8%Y/Y from 8.6%Y/Y previously. One area of particular weakness was spending on machinery and equipment, which fell 2.1%Q/Q – a decline that might suggest some impact from low levels of business confidence. The PPI outputs index for the wholesale sector rose 0.1%Q/Q in Q4, suggesting that wholesale volumes were also down modestly during the quarter. Further information on activity in the construction and manufacturing sectors will be released tomorrow. 

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