PBoC’s rate cut precedes more easing from the ECB

Emily Nicol
Chris Scicluna

Overview:
When they reopened today from the weekend, Asian markets had plenty of news to digest. From China, Friday’s announcement of further easing from the PBoC (a cut of at least 50bps in reserve requirement ratios for all banks to the lowest since 2007, with a cut of 100bps for some city commercial banks) helped to neutralize the impact of the weekend’s weak Chinese trade data (exports in USD terms down 1.0%Y/Y, imports down 5.6%Y/Y). And while Friday’s headline non-farm payroll number was soft (130k, with 20k downward revisions to the prior two months), the remainder of the US labour market report suggested nothing alarming, while comments later the same day from Fed Chair Powell saw him drop his contentious “mid-cycle adjustment” language and instead legitimize market expectations of further gradual easing ahead.

Overall, on balance, Asian markets took some comfort from this news-flow, and so most major equity markets in the region posted gains today. While Japanese GDP and business investment in the first two quarters of the year was revised down in the updated national accounts, and the latest economy watchers surveys suggested major gloom about the outlook (see detail below), the Topix closed the day up 0.9%. And China’s CSI300 closed up 0.6%.

In fixed income markets, UST yields are a touch higher this morning, but still down a few bps from the pre-payrolls peak (10Y yields at 1.57%). JGB yields are down slightly from Friday’s close (10Y yields close to -0.26%). And while yields in Europe have also ticked higher today, they remain well down from Friday morning’s peak (10Y Bunds yields up almost 2bps this morning at about -0.625%).

Of course, Frankfurt will see the main economics event this week, with the ECB set on Thursday to announce extra stimulus, the precise detail of which remains highly uncertain (we expect a 20bps rate cut, a tiering framework, and a new QE programme worth €30bn per month). And politically, the UK crisis will remain in focus. But before the UK Parliament is shut down for more than a month, MPs will again today reject Boris Johnson’s proposal for a mid-October general election, which will leave significant uncertainty as to what will occur on 17-18 October at the EU Summit and on 19 October, when the PM is likely to be compelled to write to the EU requesting an Article 50 extension.

Japan:
The second estimate of Japanese Q2 GDP, released today, broadly aligned with expectations, with the headline growth rate revised down by 0.1ppt to 0.3%Q/Q (1.3%Q/Q annualised). But with growth revised lower in Q1 too (by 0.2ppt to 0.5%Q/Q), this left the year-on-year rate of growth unchanged from Q1 at 1.0%Y/Y (down from 1.2%Y/Y in the previous estimate). Within the detail, the revision principally reflected softer than previously estimated private sector non-residential investment, with growth downwardly adjusted by 1.3ppts to just 0.2%Q/Q. This in part was offset by stronger public sector investment (up 0.8ppt to 1.8%Q/Q, a two-year high), while the 0.1ppt drag from private inventories was also revised away. Despite some modest tweaks to exports and imports, the contribution from net trade remained unchanged at -0.3ppt, the third negative contribution to growth out of the past four. As such, like in the preliminary release, private consumption accounted for the largest share of GDP growth in Q2, with the 0.6%Q/Q increase the strongest for two years and boosted by a more-than 4%Q/Q increase in spending on durable goods.

 While last week’s monthly consumption figures were more downbeat about spending at the start of the third quarter, today’s economy watchers survey provided a rare upside surprise. In particular, the headline current conditions index rose for the first month in three in August and by 1.6pts to 42.8, with a sizeable 3.6pts increase in the retail-related indicator as demand reportedly rose ahead of October’s consumption tax hike. Admittedly, these indices were still the second-lowest since mid-2016. And today’s survey reported a further marked deterioration in the manufacturing sector – with the relevant index declining 2½pts to 38.8, the weakest since the post-2011 quake low – to leave the corporate-related demand DI at its lowest for almost six years. Moreover, and particularly striking, with corporate- and household-related demand expected to weaken in the face of the more challenging external environment and the forthcoming tax hike, the outlook index fell for the sixth month out of the past five in August, by 4.6pts to 39.7, the lowest since just before the consumption tax was last raised in 2014.

Looking ahead, the MoF’s business sentiment indicators, due Wednesday, will give further insight into expected business conditions in Q419 and Q120 in the aftermath of the tax increase. The back end of the coming week will bring more insight into conditions in the current quarter too, with July’s machine orders, tertiary activity and revised manufacturing output figures due. In the markets, the MoF will auction 5Y JGBs on Wednesday.

Euro area:
In the euro area, this week will be all about the ECB, with the latest Governing Council meeting set to conclude on Thursday. At the last meeting in July, the policymakers revised their forward guidance, stating that they expect the key interest rates to remain unchanged ‘or lower’ at least through the first half of 2020. They also emphasised that they are ready to adjust all policy instruments. And in a clear sign that they are now preparing for new action, they tasked the relevant Eurosystem Committees with examining a wide range of policy options that might be taken if the medium-term inflation outlook continues to fall short of the ECB’s aim.

At the coming week’s meeting, the ECB will publish updated economic forecasts, which we expect to revise down the outlooks for euro area GDP growth and inflation over the projection horizon, while also acknowledging the continued downward skew in the balance of risks. Indeed, we suspect that the forecast for inflation at the end of the horizon, in 2021, will be revised down to 1.5%Y/Y, well below target. And with market- and survey-based inflation expectations recently having fallen to record lows to raise significant concerns about the ECB’s lack of credibility, the case for further monetary easing will be strong.

Not least given the extreme current policy settings, the precise measures which the Governing Council will take, however, are highly uncertain. We currently anticipate a package along the following lines:

A further interest rate cut seems inevitable, not least given the change to rate guidance in July. But the size of the rate cut is difficult to predict with confidence. We forecast a reduction of 20bps in the deposit rate, to -0.60%, a slightly larger cut than is currently priced in to the market.

To mitigate possible negative side-effects on the banking sector, we also expect the ECB to announce a new tiering framework for reserve remuneration. But how this might work in practice is also uncertain. We suspect that the Governing Council will prefer a system which excludes from the negative rate only a relatively small share of excess reserves (as is the case in Denmark, for example) rather than one which excludes a large share (as is the case in Japan).

To demonstrate the ECB’s willingness to do whatever it takes to achieve its inflation target, and as a full policy package combining rate cuts and net asset purchases should be considered more effective in boosting inflation than a sequence of selective actions, we also expect the Governing Council to approve a new QE programme. However, it is clear that this policy decision will not be unanimous. Hawkish members who have not favoured the ECB’s original QE programme (i.e. Weidmann, Lautenschläger and Knot) have already expressed doubts on the merits of more net asset purchases, and they are not alone on the Governing Council. Nevertheless, we think that they are in a minority. And Lane (and Draghi) will persuade a majority of members to back a new programme of net asset purchases, of about €30bn per month lasting through to end-June 2020. This will also require a decision to increase the ECB’s self-imposed issue and issuer limits, from 33% to 50%.

This week’s data calendar, meanwhile, will focus on industrial production and trade figures for July. Following last Friday’s German figures and the release of French, Italian and Spanish production numbers in the first half of the coming week, aggregate euro area IP data (Thursday) are expected to show that output reversed only a fraction of the marked decline seen at the end of Q2, to leave it still trending lower on a three-month basis and down roughly 3%Y/Y. The weakening trend will reflect to some extent ongoing soft external demand, which is likely to be highlighted in July’s euro area trade report (Friday).

In this respect, there were some slightly better German goods trade figures this morning, which saw the trade surplus rising in July by €2.2bn to €20.2bn, a fourteen-month high. This in part reflected a pickup in exports (up 0.7%M/M, 3.8%Y/Y), with year-on-year growth boosted by strong demand from countries outside the EU (9.8%Y/Y). But the improved trade position also reflected weaker domestic demand, with another notable drop in imports in July, of 1.6%M/M, the steepest for almost a year, to leave them down 0.9%Y/Y.

Meanwhile, the Bank of France’s latest business sentiment survey, published this morning, also exceeded expectations, with the headline manufacturing index rising 3pts to 99, a four-month high, reflecting a marked pickup in production last month to its highest for more than two years. With services activity also reported to have improved in August, conditions in the services and construction sector were assessed to have remained stable that month. As such, the Bank of France assessed today’s survey to be consistent with GDP growth of 0.3%Q/Q in Q3, unchanged from growth in the first two quarters of the year and bang in line with our own forecast for Q3.

In the markets, Germany will sell index-linked bonds tomorrow, while Italy will sell bonds on Thursday.

UK:
In the UK, politics will dominate at the start of the week. For a start, crucially, the legislation seeking to prevent a no-deal Brexit should gain royal assent to enter into law. Subsequently this evening, MPs are set to vote again on a Government motion seeking an early general election. While the opposition party leaders are set to meet again this morning to confirm their strategy, all the indications are that they will again reject the Government’s proposal. Following the vote, it also now appears that Parliament will be prorogued (i.e. shut down) for five weeks, to 14 October.

If things pan out in this way, there will be no general election before November. And the second half of October will be a period of high drama for Brexit and UK politics more generally. If (as seems highly likely) Johnson fails to reach a deal with the EU by 19 October, the anti-no-deal legislation will force him to request an extension of the Article 50 deadline. But, of course, recent days have seen Johnson and the Government double down on their promise not to request that Article 50 extension even if the law would compel him to do so. So, Johnson would be left in an ignominious position, having to either (1) go back on his word, (2) act against the law, or (3) resign as Prime Minister (but not necessarily as Conservative party leader) when it is time to request the extension. Reports today suggest he might be considering a combination of 1) and 2), i.e. sending the letter requesting an extension while also sending another stating that the Government doesn’t actually want one.

Of course, Johnson could belatedly decide to seek a deal with the EU, with the Irish backstop limited to Northern Ireland (as opposed to affecting the whole of the UK, leaving the border with the customs union and single market down the Irish Sea) seemingly the only game in town in this respect. But given that Johnson would lose the support of the Northern Irish DUP (and many of his party’s far-right ERG membership) this way, such a proposal would seem unlikely to gain the support of Parliament.

The UK data highlights will also come at the start of the week, with the monthly GDP, output and trade figures for July out later this morning. Having declined 0.2%Q/Q in Q2, GDP is expected to rise 0.1%M/M at the start of Q3 to leave it still down 0.1%3M/3M. Tomorrow will bring the latest labour market report, which is expected to report a notable slowing of job growth in the three months to July but no change to the unemployment rate (3.9%) or average weekly earnings growth (3.7%Y/Y). The remainder of the week will be quiet for new economic data, with just the RICS housing market survey for August coming on Thursday. Beyond the economic data, MPC member Gertjan Vleighe will speak today on a panel discussion on macroeconomic policy.

US:
In the US, while the back end will bring some notable releases, this week will start on a relatively quiet note for economic data. Only July consumer credit figures are due today with the latest NFIB small business survey and JOLTS job data due tomorrow. The following day will bring producer price figures for August, and wholesale trade and inventory numbers for July. Thursday, however, will bring the August CPI report, as well as the federal budget statement for the same month and usual weekly claims numbers. And Friday will bring August data for retail sales and import and export prices, as well as the preliminary University of Michigan consumer confidence survey for the current month.

In the markets, the Treasury will sell 3Y Notes tomorrow, 10Y Notes on Wednesday, and 30Y Bonds on Thursday.

China:
After the weekend’s aforementioned soft trade data, the data focus tomorrow will be inflation figures for August, which are likely to show a further waning in price pressures. While headline CPI is expected to fall 0.2ppt to a still-elevated 2.6%Y/Y – held up by still-rising food price inflation – producer prices are likely to have fallen further compared with a year earlier, with the headline rate forecast to fall 0.3ppt to -0.9%Y/Y, which would be the steepest drop for more than three years.

Australia:
It should be a relatively quiet week for economic releases, with perhaps most notable tomorrow’s NAB business survey for August, followed on Wednesday by the Westpac’s consumer confidence survey for September. But in light of the RBA’s acknowledgement last week that there were further signs of a turnaround in established housing markets, the latest home loan figures, published by the ABS overnight, were much stronger than expected in July, with new lending to households rising 3.9%M/M, the strongest monthly rise since October 2014, with another particularly strong rise for housing-related lending. Indeed, the value of lending for owner occupier dwellings rose more than 5%M/M, while lending for investment dwellings were up 4.7%M/M. And while this principally reflected loans to non-first time buyers, the number of loans for first home buyers rose for the fourth consecutive month. In contrast, consumer credit continued to decline, while lending to business also maintained a downward trend.

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