Upside surprise to Japan's Q1 GDP

Chris Scicluna
Emily Nicol

After last week ended on a soft note, with European and US stocks in the red (on Friday the S&P500 closed down 0.6%, slightly more than the drop on the Euro Stoxx) and government bonds still well supported (yields on 10Y USTs at 2.40% and 10Y Bunds at -0.10%), Asia-Pacific markets have been decidedly mixed today.

A big upside surprise to Japanese GDP seemingly increased the likelihood that the consumption tax will be hiked again in October. Nevertheless, the headline number barely masked a weak underlying report (detail below) and so the boost provided to stocks was fleeting, with the Topix eventually closing effectively unchanged. Meanwhile, Chinese equities fell (with the CSI300 down 0.85%) following yesterday’s Reuters report that Google has ceased the transfer of hardware, software and technical services to Huawei in response to last week’s decision by the US administration to blacklist the firm.

In contrast, equities have rallied in Australia (ASX 200 up 1.7%) in response to the surprise victory by the incumbent Liberal-National Party in Saturday’s General Election. While the pre-election opinion polls had led one bookmaker to pay out early on an opposition Labor Party victory, the Government parties, led by PM Scott Morrison, now look set to win a majority, facilitating implementation of its programme of cuts in income tax for individuals and SMEs. So, ACGB yields are higher across the curve today (2Y yields up about 5bps to 1.25% and 10Y yields up 3.6bps to 1.67%) and the market-implied probability of an RBA cut as soon as next month has slipped back close to 50%.

Looking ahead, a busy week for economic news from the major economies will see Fed Chair Powell speak publicly this evening, with the minutes of the most recent Fed and ECB policy meetings due later in the week. Datawise, euro area flash PMIs, UK and Japanese inflation, and US durable goods and Japanese machine order data are among the releases due. Elections to the European Parliament will be held in the EU from Thursday through to the weekend, with votes of most political consequence arguably in Italy, France and the UK.

The first estimate of Japanese Q1 GDP surprised on the upside, reporting growth of 0.5%Q/Q (2.1%Q/Q annualised) the fastest pace for three quarters and contrasting markedly with the consensus expectation of a modest contraction. The increase in output in Q418 was revised down slightly (by 0.1ppt to 0.4%Q/Q), but the annual growth rate still rose 0.6ppt to 0.8%Y/Y, broadly in line with Japan’s potential rate, and growth in FY18 as a whole of 0.6%Y/Y was bang in line with the BoJ’s most recent forecast. Nominal GDP growth was even firmer in Q1 at 0.8%Q/Q and 0.9%Y/Y – although this still left output roughly ¥45trn short of Prime Minister Abe’s long-held target of a ¥600trn economy.

After the Government had last week revised down its assessment of the economy, the surprise growth in Q1 certainly reduces the likelihood that Abe will postpone October’s scheduled 2ppt consumption tax increase to 10%. However, the detail of today’s report was much weaker than the headline figure. In particular, private consumption declined 0.1%Q/Q, with growth revised lower in the previous two quarters too, to leave it up just 0.4% compared with a year earlier. Non-residential investment also declined 0.3%Q/Q to leave it up just 1.6%Y/Y compared with growth of 4%Y/Y previously. In contrast, residential investment rose for the third consecutive quarter (1.1%Q/Q), while public sector investment increased for the first quarter in seven (1.5%Q/Q). But, despite a modest positive contribution also from private sector inventories, domestic demand contributed only 0.1ppt to quarterly GDP growth in Q1.

So, the acceleration in GDP growth at the start of the year was principally due to net trade, which provided the first positive contribution (0.4ppt) for a year and the largest since Q317. However, this was only thanks to a notable decline in imports last quarter – consistent with softer domestic demand – with the 4.6%Q/Q drop the steepest since Q209 and adding a whopping 0.9ppt to GDP growth. Indeed, exports were also very weak in Q1, with the 2½%Q/Q decline the largest since Q215.

While recent data suggest that the challenging external environment might well continue to weigh on Japanese exports over coming months – more details on current conditions will be provided in April’s goods trade report on Wednesday – we continue to expect a rebound in manufacturing output following the sharp contraction in Q1, which despite a slightly smaller than previously estimated decline in output in March was today confirmed at 1.4%Q/Q. And with fiscal policy set to further support growth over coming quarters, and households likely to frontload spending ahead of the scheduled consumption tax hike in October, we still expect to see positive GDP growth this quarter and next.

With respect to inflation, today’s report saw the implicit GDP deflator rise 0.3%Q/Q – the largest increase since Q317 – to be up 0.2%Y/Y, the first positive reading for a year. But the domestic demand deflator – which provides a better guide to domestic inflationary trends – was weaker, falling 0.1%Q/Q and easing to just 0.2%Y/Y, the softest annual increase for two years – hardly boding well for the BoJ’s 2% price stability target.

Looking ahead to the rest of the week, April goods trade and March machine orders data are due Wednesday. Exports are expected to remain down on the same month a year earlier, but after weakness in Q1 import growth is expected to accelerate resulting in another monthly trade deficit. Private core machine orders are expected to be broadly flat on the month, leaving them down on a year-on-year basis. In addition, Thursday brings the May flash manufacturing PMI. And Friday brings April national CPI data and the March all-industry activity index, which will include a read-out from the construction sector. Notably, the headline CPI rate is expected to rise 0.4ppt to 0.9%Y/Y partly due to increased inflation of fresh food. The BoJ forecast measure, excluding such items, is expected to rise 0.1ppt, also to 0.9%Y/Y. ‘Core core’ inflation, which also excludes energy prices, is expected to rise 0.2ppt to 0.6%Y/Y, which would be the highest since 2016. In the bond market, the MoF will auction 20Y JGBs on Wednesday.

Euro area:
The coming week will bring first top-tier economic survey results for May including, on Thursday, the flash PMIs. In April, the euro area composite PMI fell 0.3pt to 51.3, below the Q1 average, to suggest a slight loss of momentum at the start of Q2. In particular, the euro area services PMI fell 0.8pt to 52.5 while the manufacturing PMI rose 0.4pt but remained very weak at 47.9. Thursday will also bring the May business surveys from the German Ifo Institute and France’s INSEE. Other May survey results include the European Commission’s flash consumer confidence index tomorrow.

Among the hard data releases due in the coming week, today will bring the ECB’s euro area balance of payments data for March while Thursday will also bring the final estimates of German Q1 GDP (initial estimate 0.4%Q/Q) including publication for the first time of the expenditure components. Thursday will also bring the publication of the account of the Governing Council’s April monetary policy meeting. ECB President Draghi will speak publicly on Wednesday.

Of course, politics-wise, the elections to the European Parliament, to be held from Thursday (starting in the Netherlands and Ireland) to Sunday – with the largest euro area member states voting on the weekend – will be watched for any further significant increase in representation of populist and nationalist parties which could impede future EU policymaking and impact the appointments of the next heads of the EU institutions, which are due to be made shortly. Most notably, a strong showing for the nationalist League in Italy at the expense of its Five Star Movement coalition partners, particularly if accompanied by an improved performance by the other right-wing parties, could see it move to engineer a collapse of the government and trigger an early General Election. In France, meanwhile, Macron’s ‘La République En Marche’ (LREM) movement will look to replenish its domestic and European political capital by defeating Marine Le Pen’s far-right National Rally party.

In the bond market, Germany will sell 10Y Bunds on Wednesday.

Politics will continue to hog the lime-light in the UK in the coming week, although all indications now are that Theresa May will eschew the series of indicative Brexit votes in Parliament that was at one stage mooted for the first half of this week. With the next key Brexit event now likely to be the ‘second reading’ vote on May’s Withdrawal Agreement Bill in the week commencing 3 June, all eyes this week will be on the European Parliament election on Thursday, which looks set to see Theresa May’s Conservatives humiliated.

Given its deep divisions on Brexit, reflected in its failure even to agree a manifesto for the election, a YouGov opinion poll published on the weekend suggested the party is on track for its worst performance ever, perhaps ending behind the Greens in fifth place with less than 10% of the vote. Nigel Farage’s Brexit party – which, with the exception of advocating a no-deal Brexit, similarly has no policies – is set to take the largest share of the vote, albeit of less than 30% and so very similar to the showing of his UKIP party at the previous EP election in 2014. The YouGov poll also suggested that the pro-remain Lib-Dems could pip Labour for second place, representing a damning verdict for the main opposition party’s fence-sitting on Brexit.

Data-wise, the most notable UK releases of the coming week will be April’s figures for inflation and retail sales, due Wednesday and Friday respectively. We expect the core CPI rate to rise 0.2ppt to an eight-month high of 2.0%Y/Y due principally to an increase in services inflation related to the timing of Easter. And we forecast a larger increase in headline inflation of 0.3ppt to a five-month high 2.2%Y/Y due also to higher retail energy prices related to the increase in Ofgem’s regulated price cap at the start of the month.

Meanwhile, after strong growth in March of 1.0%M/M, which capped a vigorous rebound over the first quarter as a whole, retail sales likely got a further boost in April from the timing of the Easter holiday and unseasonably warm weather. Other economic data due in the coming week include the CBI’s industrial trends survey for May (tomorrow), ONS house price figures for March and the public finances report for May (both on Wednesday). BoE Deputy Governor Broadbent will give a speech tomorrow while he, Governor Carney and certain other MPC members will testify on the May Inflation Report to the House of Commons Treasury Committee the following day. In the bond market, the DMO will sell 2028 inflation-linked Gilts on Thursday.

In the US, the coming week will be lighter than of late for economic data. Today brings just the Chicago Fed National Activity indices for April, while tomorrow will bring April existing home sales data. The minutes from the May FOMC policy meeting are due on Wednesday. Along with the usual weekly claims figures, Thursday will bring new home sales data for April, and the preliminary Markit PMIs and Kansas City Fed manufacturing indices for May. And the preliminary durable goods orders figures for April are due on Friday. Meanwhile, Fed Chair Powell will speak at the Atlanta Fed Financial Markets Conference this evening. In the bond market, the Treasury will sell 10Y TIPS on Thursday.

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