Japanese output making modest recovery

Emily Nicol
Chris Scicluna

Overview:
While the WHO yesterday declared the coronavirus outbreak a Public Health Emergency of International Concern, a measured response refrained from imposing draconian new controls on economic activity. And so, financial markets in Asia have also been less extreme today. Indeed, in the forex markets, the yen reversed most of yesterday’s strength, while the offshore Chinese yuan appreciated back through 7/$. And while Japan’s latest deluge of monthly data was a mixed bag – including a stronger than expected IP report but damp-squib retail sales – the TOPIX ended the week with a rise of 0.6%M/M. In Hong Kong, however, the Hang Seng retreated again, nevertheless closing down 0.4%.

In the bond markets, meanwhile, USTs are little different from this time yesterday (10Y yields close to 1.57%). And JGBs made just modest gains up to 10Y maturities, but were somewhat weaker among super-longs where the gains of the past week or so have been marked. Against this backdrop, the BoJ’s revised bond purchase schedule for February saw a reduction in the number of scheduled operations of bond buying at the longer end of the curve, from 3 times in the month to 2, albeit increasing slightly the upper range of the amount of 10-25Y JGBs that it could potentially buy at each operation by ¥50bn.

In Europe, most equity markets have opened a touch higher, and euro area government bonds opened a touch softer, despite a much weaker-than-expected French GDP report for Q4 – with the first negative print in more than three years – and a shockingly poor German retail sales figure that seems bound to be revised up in due course. The first estimates of euro area Q4 GDP and January inflation come later this morning. And, of course, tonight will see the UK formally leave the EU.

Japan:
The latest deluge of Japanese data overnight provided mixed messages about economic conditions at the turn of the year. Overall, however, the modest recovery reported in the manufacturing and retailing sectors in December was inevitably not sufficient to offset the post-tax hike and natural disaster-associated plunge in activity seen earlier in the quarter. And inflation remained very subdued despite a still very tight labour market.

Certainly, the pickup in industrial production in December (1.3%M/M) was a little more encouraging, marking the first monthly increase since September and a touch stronger than the Bloomberg consensus. But this fell well short of what surveyed manufacturers had been expecting and ultimately represented a subdued recovery from the marked weakness earlier in the quarter. Indeed, this left output down a whopping 4%Q/Q in Q4, the steepest quarterly drop since the aftermath of the Great East Japan Earthquake in 2011.

Within the detail, the improvement in December was led by the production machinery sector, with the near-16%M/M increase the strongest since the series began in 2003. There were solid increases in general and electrical machinery output too. But autos production continued to disappoint, with the ½%M/M decline reversing the increase seen in November to leave output down almost 10%Q/Q in Q4.

While the flash manufacturing PMI for January (published a week ago) signalled a further improvement in conditions in the sector at the start of the year, and METI today offered a particularly optimistic expectation from manufacturers about the near-term outlook (forecasting production growth of 3½%M/M in January and more than 4%M/M in February), other detail of today’s report suggested otherwise. Indeed, there was a further notable increase in inventories in December to their highest level since the height of the Global Financial Crisis. This left the inventory-shipment ratio surging to its second-highest level since the series began in the late 1970s with an increase of 27%Y/Y consistent with further significant declines in annual rate of production growth over the coming six months. Certainly, the anticipated hit to China’s growth in Q1 (at least) due to the coronavirus will have a knock-on effect on demand for Japanese goods from that country and potentially elsewhere in Asia, suggesting an underwhelming outlook for Japan’s manufacturing sector over the near term.

Of course, the decision to stop all travel to and from China will also have consequences for Japan’s services sector, with spending by Chinese tourists accounting for roughly one-fifth of total spending by overseas visitors. But even before the outbreak of the coronavirus gained greater prominence, the recovery in Japan’s retail sector at the end of last year was somewhat disappointing. Certainly, the 0.2%M/M increase in retail sales in December fell short of expectations. Admittedly, the weakness in part reflected clothing sales which were reportedly impacted by unseasonably warm weather than month. Nevertheless, this still left sales down more than 2½%Y/Y and a sizeable 6.1%Q/Q in Q4, only slightly smaller than the equivalent decline seen in the quarter following the 2014 tax increase. It is worth noting, however, that retail sales figures rarely provide a good guide to the national accounts measure of consumption.

The latest labour market figures were at least more encouraging. In particular, employment rose for the sixth month out of the past seven in December, with the 130k increase that month leaving the total number of people employed at a new record high (67.82mn), an increase of 850k over the past year. As such, the unemployment rate moved sideways at 2.2%, the joint-lowest since 1992 and arguably implying the tightest labour market of the major economies. The job-to-applicant ratio (unchanged at 1.57x) similarly continued to signal supply constraints in the labour market, albeit to a lesser extent than over recent years. And while new job offers have trended lower over the past six months, they still remained at a relatively high level, suggesting that employment growth should maintain an upward trend.

Finally, with respect to inflation, today’s Tokyo CPI figures for January fell slightly short of expectations. In particular, headline inflation declined 0.4ppt to 0.6%Y/Y (0.3%Y/Y when excluding the impact of the consumption tax hike and government education policies). Admittedly, the downwards shift principally reflected weaker fresh food price inflation, down 6.4ppts to 1.1%Y/Y, in part reflecting a significant decline in the year-on-year increase in lettuce prices (down more than 50ppts to 1.7%Y/Y).

When excluding fresh food, the BoJ’s forecast measure of core CPI in Tokyo was down just 0.1ppt to 0.7%Y/Y (0.4%Y/Y). Despite a notable pickup in gasoline prices, weaker electricity and gas charges weighed on energy price inflation. And so, when excluding fresh foods and energy, the BoJ’s preferred measure of Tokyo core CPI moved sideways at 0.9%Y/Y (0.7%Y/Y), nevertheless suggesting still very subdued underlying price pressures.

Like with the growth outlook, we think risks to the inflation outlook remain skewed to the downside. Certainly, the weaker oil price and soft demand (both at home and overseas) will weigh on price pressures. And the introduction of free higher education fees in April will see headline CPI take a further step down too. So, while the BoJ last week nudged down very slightly its inflation forecast over coming years, we continue to think that it remained too optimistic. Indeed, we would expect core inflation at the national level to average around ½% this year (at best) and little stronger over coming years too.

China:
With the cut-off date for survey responses being 20 January, today’s official Chinese PMIs for January offered little insight into current macroeconomic conditions. Indeed, despite the massive hit to services activity from the coronavirus – illustrated most starkly by the strict travel restrictions that continue to be extended – the non-manufacturing PMI rose 0.6pt from December to an unlikely 54.1. The manufacturing PMI edged lower to 50.0, with the 0.2 decline from December smaller than usual for the Lunar New Year. For what it’s worth, the manufacturing output PMI fell 1.9pt to a three-month low of 51.3, while the new export orders index fell 1.6pts to 48.7, suggesting a renewed downturn in new bookings from abroad. The impact of the coronavirus should be more obvious in the February PMIs, but the likely eventual hit to activity is obviously impossible to gauge precisely at present.

Euro area:
It’s a busy end to the week for euro area economic data, bringing the flash estimate of January inflation and, perhaps most notably, the first estimate of the region’s GDP in Q4. Yesterday’s initial figures from some of the smaller member states – Belgium (0.4%Q/Q), Austria (0.3%Q/Q) and Lithuania (a vigorous 1.3%Q/Q) – surprised on the upside. But this morning’s French numbers strikingly did the opposite.

Indeed, contrary to the consensus expectation of growth of 0.2%Q/Q in Q4, French GDP fell 0.1%Q/Q marking the first decline since Q216. That left it up just 0.8%Y/Y, likewise the softest annual rate in more than three years. The detail was weaker across the board. Growth in private consumption halved from Q3 (0.2%Q/Q), and fixed investment slowed a full 1.0ppt to 0.3%Q/Q. Trade was very weak on both sides of the ledger, but imports and exports were both down 0.2%Q/Q to have a neutral impact on GDP. But inventories subtracted 0.4ppt from growth.

In contrast, and beating expectations, Spain’s economy accelerated in Q4, with GDP up 0.5%Q/Q, 0.1ppt stronger than the rate of the previous two quarters. The detail showed that consumption growth was subdued (0.1%Q/Q), and fixed investment fell (down 2.5%Q/Q). But imports fell 1.2%Q/Q and exports rose 1.5%Q/Q so that net trade provided a significant boost. Elsewhere in Southern Europe, data due later this morning are likely to show that Italy’s economy moved broadly sideways. And that should mean that euro area GDP rose 0.1 or 0.2%Q/Q, down from upwardly revised growth of 0.3%Q/Q in Q3.

For the euro area figure, much, of course, will depend on what happened in Germany. But there will be no official figure from the euro area’s largest member state until Valentine’s Day. If this morning’s retail sales figures are anything to go by, however, German GDP will have been very weak indeed. According to the preliminary figures, German retail sales in December plunged a huge 3.3%M/M, the most in more than two decades, with sharp declines in every category (e.g. sales of clothing and footwear were down almost 9%M/M, while sales of IT items were down almost 5%M/M). The sheer magnitude of the drop is hard to explain, and sales seem bound to be revised up in due course. Indeed, Destatis noted that December has seen significant revisions over recent years, with the monthly rate that month adjusted on average by 2ppts in the past four years. Nevertheless, for the time being, today’s data imply a drop of 0.7%Q/Q in Q4, which would represent the weakest quarter for sales since the euro crisis in Q112.

In addition to the activity data, this morning will also bring the flash estimates of January inflation from the euro area. We expect the headline rate to have edged slightly higher at the start of the year, by 0.1ppt to 1.4%Y/Y due principally to higher energy prices. Indeed, with underlying price pressures still subdued, core inflation likely slipped back in January by 0.1ppt to 1.2%Y/Y. This would be consistent with yesterday’s German figures (which saw the annual rate on the EU measure rise 0.1ppt to 1.6%Y/Y, while this morning’s French numbers saw the EU-harmonised rate fall slightly short of expectations, unchanged at 1.6%Y/Y.

UK:
Following yesterday’s BoE announcement, which saw Bank Rate left unchanged at 0.75% as members assessed that the recent recovery in sentiment following December’s election had been broadly in line with their expectations, today’s GfK consumer confidence survey saw the headline sentiment index rise 2pts to -9, its beat reading since September 2018. But while households were more positive about the outlook for the economic outlook and their personal finances, they considered the climate for making major purchases to be less favourable than in December, supporting our view that household spending growth is likely to remain subdued. This notwithstanding, this morning’s other release – the BoE bank lending data for December – is likely to mirror the findings from UK Finance data published earlier this week that showed a sizeable increase in mortgage approvals and stronger consumer credit too.

Of course, at 23.00 GMT today the UK will leave the EU. Apart from losing its representation in EU decision-making, however, nothing of substance will change. The UK will continue to benefit from all the rights and fulfil all the obligations of EU membership throughout the transition period, set to last at least until the end of the year.

US:
In the US, today will bring personal income and spending data for December, which are expected to report moderate growth in both components. The associated core PCE deflator, the Fed’s preferred measure of inflation, is expected to be unchanged at 1.6%Y/Y. In addition, the employment cost index for Q4 is due along with the final University of Michigan consumer confidence survey for January.

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