ECB announcements continue to reverberate

Chris Scicluna

Overview:
Most Asian-Pacific equity markets that were open today ended the week with further gains, given a boost by reports that the Trump administration were mulling the possibility of an interim agreement on trade with China (“it’s something we would consider, I guess” said the President). And with the yen still weaker close to 108/$, Japanese equities once again led the way, with a further gain of 0.9% in the Topix taking the rise over the week to a striking 4.7%. Elsewhere, the Hang Seng is currently up about ½%, while markets in China and Korea were closed for the Mid-Autumn Festival holiday.

Of course, yesterday it was bond markets that caught the eye, after the ECB’s policy announcements saw short-dated euro govvies sell off and curves in the region flatten significantly. That partly reflected the announcement of a Swiss-style tiering framework to exempt a significant share (roughly 35-40%) of banks’ excess reserves from the -0.50% deposit rate. But with several Governing Council members opposed to the resumption of QE – at a modest €20bn per month, albeit for the time being on an open-ended basis – it also reflected the ECB’s message that euro area monetary policy was reaching the limits of its abilities to support growth and inflation, and that fiscal policy should instead step up to the plate. And euro area govvie yields are higher across the curve again this morning, with German 2Y yields up 2bps to –0.715% and 10Y yields more than 2bps higher to above -0.50% for the first time since early August. Unlike yesterday, Italy and Spain are underperforming, with yields on 2Y BTPs up 10bps to close to -0.14%.

In a similar vein to the euro area, monetary policy in Japan appears close to its limit too. And reports today that BoJ officials favour setting a floor to the 10Y JGB yield around -0.30% – with any sustained shift or surge below that level prompting consideration of further action – prompted a marked upwards shift in the JGB curve today, with 10Y yields up more than 5bps to -0.17%, the highest level since the start of August. Having been buffetted significantly yesterday by events in Europe, however, USTs were little changed in Asian time, with 10Y yields still about 4bps higher than this time yesterday at about 1.78%. There remains scope for further volatility today, however, not least on the back of today’s most notable economic data release, US retail sales figures for August.

In FX markets, sterling is a touch stronger (above $1.24 for the first time since July) seemingly supported by reports – led by the Times – that the Northern Irish DUP has “agreed to shift its red lines in a move that could help to unlock a Brexit deal”. Most notably, the reports suggest a willingness of the DUP to accept some EU rules after Brexit, and thus also accept some regulatory checks in the Irish Sea and diverge from the rest of the UK. That report, however, has been refuted by DUP leader Arlene Foster, who tweeted that the “UK must leave as one nation”.

Even if – as must be highly doubtful – Boris Johnson managed to reach an agreement with the EU on a new deal, which by necessity avoided border infrastructure on the island of Ireland, we remain sceptical that he would be able to find a sufficient number of MPs (whether or not the DUP was onside) for it to be approved by the House of Commons. Certainly, the most nationalist Conservatives within the ERG would seem likely to remain opposed. And the vast majority of Labour MPs would likely view any deal proposed by Johnson as inferior to the one proposed by Theresa May which they previously rejected on three occasions. Judging from yesterday's comments from the party leadership, they would also seem unlikely to be willing to approve it subject to a second referendum (i.e. with the Kyle-Wilson amendment attached). So, we attach a strong probability to an end-October Article 50 extension and a general election at end-November or early December.

Japan:
It was a very quiet end to the week for economic releases from Japan, with final data for industrial production in July unusually merely confirming the initial estimate. Admittedly, the 1.3%M/M increase had originally exceeded expectations. But it reversed only a small part of the 3.3%M/M drop in June. So, while it left output up just 0.7% compared with a year earlier, it was still down 0.3% compared with the average level in Q2.

Within the detail, the improvement principally reflected an 8.6%M/M increase in business-oriented machinery output – an admittedly volatile series but nevertheless the strongest growth since October 2014. Production of cars and auto parts also reversed some of the weakness seen in June. But output of ICT equipment continued to decline (down 4.1%M/M following a 10.5%M/M drop in June). Looking ahead, surveys point to renewed weakness over the remainder of the quarter. And so, following a rise in industrial output of 0.7%Q/Q in Q2, we expect to see a drop in Q3.

Euro area:
After yesterday’s excitement at the ECB, the end of the week in the euro area will bring labour cost figures for Q2 and July’s trade report. With German figures earlier in the week having reported a step up in labour costs growth last quarter to the strongest annual rate for two years, we should see a modest increase in the euro area aggregate number from growth of 2.4%Y/Y in Q1. Meanwhile, some slightly stronger German export figures, as well as a decline in imports, should also feed through to an improved trade position for the euro area as a whole at the start of Q3. Final Spanish CPI figures for August just released confirmed that the EU-harmonised rate fell 0.2ppt to 0.4%Y/Y, the lowest since November 2016.

US:
Today’s most notable economic releases will come from the US, with retail sales figures for August the highlight. These are expected to show only modest growth last month (BBG consensus of 0.2%M/M, both in terms of the headline number and ex autos and gasoline) after a strong increase in July. The preliminary University of Michigan consumer confidence survey for September will also be closely watched, with the headline index having previously fallen to the lowest since October 2016 but expected to tick higher today. Import and export price numbers for August and business inventories figures for July are also due.

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