UK Budget to provide near-term support

Chris Scicluna

Wall Street weaker overnight but markets mostly firmer in Asia today, greenback erases gains while 10Y UST steadies at 1.4%
After beginning the week with the biggest rally in almost nine months, a slightly nervous Wall Street traded with a negative bias yesterday. Despite a mid-session recovery that had taken the broader market back to flat, stocks fell away in late trade to leave the S&P500 down 0.8% and the Nasdaq down 1.7%. In the Treasury market, for the most part the 10Y UST moved through the prior day’s range of 1.40-1.45%, closing at the bottom – and remaining there in Asian trading – after Fed Governor Brainard said that she was paying “close attention” to recent market developments that could slow the economic recovery. Meanwhile, the greenback fell back out of favour, with DXY unwinding all of the gains that it had made on Monday.

US equity futures have gained a few tenths since the close, however. So, with a number of Asian bourses having posted sizeable losses yesterday, the tone in the region has been more positive today. In China, the CSI300 continued its recent yo-yo, rebounding 1.6% despite the Caixin services PMI confirming that slightly softer picture seen in the weekend’s official PMI. The Hang Seng is up a steeper 2.6%, thus reversing course for a dizzying 10th consecutive session.

By contrast, having closed little changed yesterday, Japan’s TOPIX posted a more modest 0.5% advance today. Pleasingly, the final results of Japan’s services PMI cast the sector in a more positive light than seen in the preliminary report. However, according to media reports, Governors in the four Tokyo-area prefectures are considering asking PM Suga to approve a fortnight extension to the current state of emergency, which is due to end on Sunday.

In Australia, sentiment was supported by news of a stronger-than-expected rebound in economic activity in Q4, with incomes boosted further by the impact of rising export commodity prices. However, with Aussie bond yields unwinding yesterday’s sharp post-RBA sell-off on today’s open, the 10Y ACG closed down 4bps at 1.67% despite yields lifting somewhat following the release of the GDP report. Meanwhile, longer-term JGB yields also closed a fraction lower today.

Japan’s services PMI revised up to record a modest lift in February, and firms see better times ahead
The only economic report of note in Japan today was the final reading of the Jibun services PMI for February. In a somewhat pleasant surprise, the completed survey cast the sector in a firmer light, with the initial 0.3pt decline in the headline business activity index erased and replaced instead with a 0.2pt lift to 46.3 – still about 1½pts weaker than had been the average through Q4, however. In the detail, the new orders index was also revised up 0.5pts to 44.8, thus leaving it down just 0.1pts from last month. Most encouraging of all, the business expectations index was revised up a substantial 2.1pts to 56.8 – now up 3.3pts on its January reading and at the highest level since January 2018. Meanwhile, the output prices index was revised up 0.3pts to 48.7, leaving it only fractionally weaker than last month.

Combined with the upward revisions seen in Monday’s manufacturing survey, today’s service sector results meant that the composite PMI output index was revised up 0.6pts to a final reading of 48.2, thus leaving it up 1.1pts from January and just 0.3pts below the post-pandemic reached the month prior. So while it still seems likely than restrictions on activity will cause GDP to take a backward step during current quarter, today’s report adds to the range of recent indicators suggesting that this pullback might be smaller than feared earlier.

China’s Caixin services PMI slips in February, consistent with official data
Today’s Caixin services PMI for February confirmed the further softening in activity reported in the weekend’s official survey. The headline index fell 0.5pts to a 10-month low of 51.5, in line with the market expectations and just 0.1pt firmer than the official index. In the detail, the new orders index fell 1.2pts to 51.8 and the employment index slumped 2.9pts to 47.9. A ray of light was cast by the business expectations index, which increased 1.4pts to 63.6 but remained 3.1pts below where it had ended last year. Combined with the similar softening in the Caixin manufacturing PMI, today’s results for the services sector yielded a 0.5pt decline in the composite PMI output index to a 10-month low of 51.7 – still consistent with expansion, but at a much slower pace than seen over most of last year. Attention will now turn to China’s trade data for the January/February period, which is due for release on Sunday.

Merkel to discuss modest lockdown relaxation; German car production and sales data due
Chancellor Merkel will today discuss with German regional leaders plans to extend most of the current pandemic restrictions, most likely until 28 March, albeit with some modest relaxations – such as the reopening of bookshops and florists, and permission for five members of two households to meet – from next week. Data-wise, German car production and registration data for February are due, with the former likely to be impacted in part by supply-chain strains (including regarding semiconductors) while – like France, Italy and Spain which published their data at the start of the week – the latter will be weak as the reversal of the temporary VAT compounds the impact of lockdown restrictions.

Today will also bring the release of the final euro area services and composite PMIs for February. With the sector still significantly affected by containment measures, the flash services sector indices suggested ongoing contraction – the euro area activity PMI dropped 0.7pt to 44.7, still above November’s recent trough but slightly below the Q4 average. And the euro area composite PMI was little improved from January, up just 0.3pt to 48.1 to suggest ongoing contraction in euro area GDP at the start of the year.

UK Budget to provide near-term support before a tightening of the fiscal stance next year
Fiscal policy will be the focus in the UK as Chancellor Sunak presents his Budget statement, with the measures set to have a significant bearing on the near-term economic outlook. Certainly, the Government will extend its main business support programmes to better match its timetable for reopening the economy. So, for example, the Job Retention Scheme will now remain in its current format until end-June before being tapered over the third quarter. Some measures, including support for the self-employed, retail, hospitality and the housing market will also be tweaked or enhanced, while sectors such as the arts that have to-date largely missed out on the fiscal largesse are set to benefit from cash hand-outs too. And there will also be an extension of the temporary increase to Universal Credit benefits through to September. But the Chancellor will also likely set out a plan to tighten fiscal policy, including via higher taxes on the corporate sector, from next year once economic recovery is likely to be well underway. Given stronger revenues, the OBR will be able to revise down its forecast of borrowing in FY20/21 of £339.9bn. But while it will also likely revise up its GDP forecast for the coming fiscal year, it will likely also revise up its forecast of borrowing in FY21/22 too (from £164bn).

Data-wise, like in the euro area, the final UK services sector and composite PMIs for February are due this morning. The flash PMIs revealed an improvement in services, suggesting a better ability of firms in the sector to cope with pandemic containment measures. Having dropped almost 10pts in January to an eight-month low of 39.5, the services activity PMI rebounded to 49.7 suggesting broad stability. And, as a result, the composite PMI rose 8.6pts to 49.8, similarly suggesting little change to overall economic output last month.

Aussie GDP grows faster-than-expected 3.1%Q/Q in Q4, but RBA unlikely to change course
The domestic focus in Australia today was on the release of the latest set of national accounts. Pleasingly, GDP rebounded a further 3.1%Q/Q in Q4 – 0.6ppts greater than analysts had estimated based on the available partial indicators. So with growth in the prior quarter also revised up a notch to 3.4%Q/Q, the annual decline in output now sits at just 1.1%Y/Y – 0.8ppts smaller than analysts had estimated. As expected, nationwide growth was boosted by the gradual removal of lockdown restrictions in Melbourne. Indeed, final demand grew 6.8%Q/Q in the state of Victoria, far outpacing growth elsewhere.

Turning to the key expenditures, a further 4.3%Q/Q lift in household consumption contributed about three-quarters of the overall rise in activity. Of particular note, benefitting from the removal of restrictions on activity, spending on services increased a further 5.2%Q/Q in Q4. However, the recovery here remains far from complete, with such spending still down 7.8%Y/Y. By contrast, spending on goods increased 2.8%Q/Q – about what had been suggested by the retail sales report – but was up 6.2%Y/Y.

Consistent with the upward trend in building approvals, residential building activity increased a solid 4.1%Q/Q. However, a further 1.9%Q/Q decline in commercial construction provided a partial offset to that growth. Encouragingly, investment in machinery and equipment increased a strong 8.9%Q/Q – the first increase since Q219 – reducing the annual contraction in such spending to 4.3%Y/Y. Spending on intellectual property increased 1.4%Q/Q, but given the sharp decline recorded during the first half of last year was still down 5.4%Y/Y. Meanwhile, as indicated yesterday, public demand made a positive contribution to growth, with government consumption spending rising 0.8%Q/Q and investment spending rising 2.5%Q/Q. As yesterday’s BoP data had also indicated, net exports subtracted 0.1ppt from growth in Q4, with a 3.8%Q/Q lift in exports slightly outpaced by a 4.9%Q/Q increase in imports. Finally, inventories made a small 0.1ppt negative contribution to growth in Q4.

Elsewhere in the accounts, rising export commodity prices resulted in a 4.7%Q/Q lift in the terms of trade, which are now up a substantial 7.4%Y/Y. As a consequence, nominal GDP grew 4.2%Q/Q in Q4 – the strongest quarter since 1983 – and so was up 0.6%Y/Y. A strengthening labour market lifted compensation of employees by a solid 1.5%Q/Q, but a decline in government support payments resulted in a 4.0%Q/Q decline in households’ gross operating surplus. While the sharp improvement in the terms of trade resulted in a 1.1%Q/Q lift in the GDP deflator, the domestic final demand deflator increased just 0.3%Q/Q and 0.4%Y/Y. Finally, the lift in hours worked during Q4 more-or-less matched the increase in output. As a result, labour productivity was flat in the quarter but still up 2.5%Y/Y.

Today’s report represented another positive surprise for the RBA, which last month had forecast that output would be down 2%Y/Y in Q4 (rounded to the nearest ½ppt as is the RBA’s convention). Of course, the RBA does not have a target for GDP growth, which is important to the Bank only insofar as it helps drive the outlook for the labour market, wages and ultimately CPI inflation. So while Governor Lowe will doubtless welcome today’s figures when he makes his next scheduled speech a week from today, investors should anticipate that he will maintain his stridently dovish prognosis for monetary policy. In our view, it will take a sustained series of downside surprises to the unemployment rate over the remainder of this year (if not longer) in order to prompt the RBA’s Board to reassess the outlook for policy.

In the near term, we expect that Australia’s economy will prove to have grown further during the current quarter – growth of around 1-1½%Q/Q seems readily achievable – which would lift activity back to around the pre-pandemic level. Household consumption would appear to have scope for further recovery as while the household savings rate declined to 6.9ppts in Q4 to 12.0%, it remains more than double the pre-pandemic trend (as a result, household consumption remains down 2.7%Y/Y). Given the sharp run-up in building approvals at the end of last year, there is clearly scope for a sizeable lift in residential construction too.

Aussie services PMI revised lower in February, consistent with GDP growth slowing to a more sustainable level
Turning to today’s other Aussie news, the headlines services PMI index – which measures business activity – was revised down 0.7pts from its flash estimate to a final February reading of 53.4 – down 2.2pts from January and the softest reading since February. While the new orders index was revised up 0.2pts to 53.8, this was down 1.3pts for the month. However, firms would appear to be confident about the medium-term outlook as the employment index was revised up a welcome 0.5pts to 54.8 – up a substantial 2.9pts from January to the highest reading since the survey began almost five years ago. Combined with information from the manufacturing sector, the composite PMI was revised down a similar 0.7pts to a 4-month low of 53.7 – consistent with ongoing GDP growth, but understandably not at the 3%-plus rates seen over the final two quarters of last year.

ISM services survey the focus in the US today; ADP employment report and Fed’s Beige Book also due
Following the surprisingly strong ISM manufacturing report release at the beginning of the week, attention today will turn to the release of the ISM services report for February. Daiwa America Chief Economist Mike Moran expects the headline business activity index to drop a modest 0.7pts to 58.0, which would leave it at robust levels and within the narrow range recorded since the middle of last year. Ahead of Friday’s payrolls report, the evolution of the employment index will also be of interest, especially in light of the sharp improvement recorded in January. The ADP employment report for February will similarly hold interest, whereas the final Markit services PMI reading for February will likely be largely ignored. Later in the day, the Fed’s Beige Book will offer further insight into the economy’s trajectory. Meanwhile, investors will want to continue to monitor the passage through the Senate of President Biden’s stimulus package.

Kiwi house price inflation hits 14.5%Y/Y in February ahead of new LVR restrictions; dwelling approvals hit a new record high in January
Almost inevitably, the Corelogic house price index increased to a new record high in February as purchasers rushed to get in ahead of the re-imposition of LVR restrictions on 1 March. Indeed, with prices rising by 7.6% in just the last three months, annual home price inflation reached a new high of 14.5%Y/Y, up from 12.8%Y/Y in January. Looking ahead, in our view it is very likely that house price inflation will slow from here due to the RBNZ’s macro-prudential tightening and the likelihood that an embarrassed left-of-centre Government will soon announce further measures to reduce investor demand. Measures to boost the supply of housing will likely also be a key feature of the Budget in May. The latter will be difficult with the housing construction sector already running at full steam. Indeed, in today’s other Kiwi news, the number of dwelling approvals increased a further 2.1%M/M in January to be up 18.0%Y/Y. Indeed, notwithstanding the pandemic, the number of approvals issued over the last 12 months is now just shy of the record high recorded for any 12-month period, which occurred back in 1974. 

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