Disinflationary pressures becoming more evident

Chris Scicluna
Emily Nicol

After another day of bad news from Asia to Latin America – from China’s softer lending data to the escalation in Hong Kong’s protests and Argentina’s complete market rout (peso down almost 30% and local stocks down 38%) – yesterday’s weaker showing in US equities was perhaps inevitably followed by declines in Asian markets today. As the yen reversed an earlier decline to strengthen back through 105.5/$, Japan’s Topix closed down 1.1%. And while the PBoC set the daily yuan fix only slightly weaker again, China’s CSI300 fell 0.9% and the Hang Seng was down roughly twice as much.

But events in bond markets have arguably been most notable, with further gains in the major markets. Yields on USTs are down 1.5bps or more, with 30Y yields down below 2.11%, within a couple of bps of the record low, and further curve flattening consistent with increased recession fears. Elsewhere, as the latest Japanese producer price data flagged the growing disinflationary impulse from the stronger yen (see detail on this and the other Japanese, Aussie and German data already released today below), yields on 10Y JGBs fell to -0.24%, raising expectations that the BoJ will soft-pedal at its scheduled purchase operation of 5-10Y bonds on Friday. In addition, 30Y yields fell close to 0.17%, only about 5bps above the record low.

In Europe too, bonds have made further gains, with yields on 10Y Bunds now down to a new low below 0.61%, and 10Y BTPs also down another 2bps at 1.68%, having dropped 10bps yesterday on hopes that an early election might be avoided by formation of a temporary technocrat ‘institutional government’, backed by Five Star and the centre-left Democrats, tasked with producing a Budget for next year. That, however, is far from certain. In the meantime, Italy’s Senate leaders look set this evening to confirm that the vote of no-confidence, that will put the current government out of its misery, will be confirmed for one week today. Data-wise, finally, today brings some noteworthy releases including the latest UK labour market and US CPI reports.

While the first estimate of Q2 GDP last week showed that Japan’s economy expanded at a healthy pace (0.4%Q/Q), today’s monthly tertiary activity figures for June tentatively added to evidence suggesting that economic momentum slowed towards the end of the second quarter. In particular, tertiary activity fell 0.1%M/M in June following no growth in May to leave the annual rate of increase unchanged at just 0.6%Y/Y. The weakness in June was driven by a drop in finance and insurance services (-2.0%M/M), while retail trade and transport activity fell for the second successive month. In contrast, wholesale trade output provided a modest boost that month, as did medical care and tourism-related services.

Of course, the weakness over recent months was to some extent payback for the strength at the start of the quarter (output rose 0.8%M/M in April), so tertiary activity was still up 0.3%Q/Q in Q2. Moreover, recent surveys – including July’s PMI and Reuters Tankan – suggest that, in marked contrast to the manufacturing sector, conditions in services remained broadly stable at the start of Q3, still – for the time being at least – signalling ongoing moderate growth in the sector.

With respect to inflation, today’s goods PPI data reported a further moderation in pipeline price pressures at the start of Q3. While producer prices were unchanged on the month in July, this reflected a notable increase in electrical power prices that month. Indeed, excluding extra charges for summer electricity, producer prices were down for the third consecutive month, to leave them down 0.6%Y/Y, the second successive year-on-year decline and the steepest since 2016. Among other things, the impact of the recent yen strength was evident in today’s release, with import prices in yen terms down a hefty 8.1%Y/Y in June, similarly the largest drop since late-2016.

Within the detail, the largest price decline came from petroleum and coal products, while prices in the nonferrous metals sector were once again down too. So, with prices of raw materials down almost 9½%Y/Y in July, it was not particularly surprisingly to see final corporate prices for consumer goods decline for the third consecutive month to push annual inflation on this measure further into negative territory at -1.6%Y/Y. And while prices of imported items were down a hefty 4.4%Y/Y, there was a further weakening in domestic inflationary pressures too. So, overall, today’s figures provided further evidence that underlying consumer price inflation remains very subdued.

Euro area:
There were no surprises from today’s final German inflation figures for July, which showed the headline EU-harmonised CPI rate unrevised from the flash estimate at 1.1%Y/Y, down 0.4ppt from June and the lowest since November 2016. While there was upwards pressure from food and clothing price inflation last month, the core inflation measure on the harmonised basis fell 0.6ppt to 0.9%Y/Y reflecting a notable drop in recreational services inflation, not least reflecting lower prices of package holidays. Indeed, the differing methodology concerning package holidays underpinned the discrepancy between the harmonised and national measures of inflation in July, with the national CPI rate increasing 0.1ppt to 1.7%Y/Y and the core rate on this basis unchanged at 1.6%Y/Y, suggesting firmer underlying price pressure.

In contrast to Germany, but similar to Italy last week, the Spanish figures this morning showed a modest downwards revision to the EU-harmonised rate in July, by 0.1ppt to 0.6%Y/Y, leaving it unchanged from the 2½-year low seen in July.

Later this morning will also bring the German ZEW survey of financial market analysts, which, not least given the sharp fall in equity markets so far this month, is likely to report a further deterioration in both the current conditions and future expectations balances in August. In the markets, Italy will sell 3Y and 7Y bonds against the backdrop of political turbulence.

The main economic focus in the UK today will be the latest labour market figures. In particular, employment growth is expected to have picked up in the three months to June, from an equivalent increase of 26.6k in May, not least due to the strength in April (up 434k). So, the headline unemployment rate is expected to remain unchanged at 3.8% in June. Meanwhile, average earnings growth in the three months to June is expected to have risen 0.3ppt to 3.7%3M/Y boosted by public sector wage growth – indeed, in May public sector wages rose at the fastest pace in eight years on the back of a change in timing of pay increases of some NHS staff this year compared with last.

In the markets, the DMO will sell 30Y Gilts.

In the US, the main data focus today will be July’s CPI inflation. Despite an anticipated 0.3%M/M pickup in prices last month, the annual CPI rate is expected to remain comfortably below 2%Y/Y at about 1.7%Y/Y. And the core CPI is expected to tick up 0.2%M/M to leave the annual rate moving sideways at 2.1%Y/Y. This afternoon will also bring the NIFB small business survey for July.

The NAB’s latest monthly business survey suggested little change in the underlying trend in Australia business conditions at the start of the third quarter, while also pointing to little improvement over the near-term. Admittedly, the headline business confidence index rose in July, by 2pts to 4. But this followed a notable decline in June, to leave it still well below the long-run average. And the business conditions index slipped back in July to the second-lowest reading since September 2014. There was also another decline in forward orders in July for the sixth consecutive month, while firms assessed their profitability to be still weak and well below average. So the survey also indicated a predictable deterioration in employment and capex conditions.

Turning to the sectoral breakdown, the weakness in the retail sector was again the most striking, with conditions consistent with recessionary levels. But manufacturing and construction conditions are also weaker. This is offset to some extent by improvements in conditions in the mining and finance sectors.

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