Monetary policy and politics in focus

Emily Nicol
Chris Scicluna

At the start of what is set to be a busy week for economic and political news from the major economies, most major Asian equity markets have posted gains in the wake of Friday’s upbeat US payroll data (up 266k in November, with 41k of positive net revisions over the prior two months). Japanese markets also felt the benefit from some very large upwards revisions to economic growth in each quarter of this year (detail below), and so the TOPIX closed up 0.5% on the day. In contrast, the CSI300 fell 0.2%, weighed by the weekend’s disappointing Chinese export data. In the bond markets, after yields moved steadily higher from Wednesday on, USTs are little changed so far today (10Y yields close to 1.83%). JGBs were similarly broadly unchanged (10Y yields close to -0.02%). But euro area govvies have opened a touch stronger despite some better German export data.

Looking ahead, highlights this week include the latest policy announcements from the Fed (Wednesday) and ECB (Thursday, in what will by Christine Lagarde’s first policy meeting as President) – no changes to current policy, or guidance on future policy, are expected from either meeting. Meanwhile, Thursday’s UK General Election is expected to deliver a parliamentary majority for current PM Johnson that will result in the UK leaving the EU at end-January – with most weekend polls giving the Conservatives a lead of about 10ppt over Labour, sterling hit a new more than two-year high against the euro this morning. The week’s dataflow includes inflation figures from the US and China, monthly GDP from the UK, industrial sector numbers from the euro area, and, on Friday, the latest BoJ Tankan.

The main focus in Japan at the start of the week was the updated GDP figures. While the initial estimate of growth in Q3 had implied that the economy expanded by an underwhelming 0.1%Q/Q, today’s release saw headline growth upwardly revised by a much larger-than-expected 0.3ppt to 0.4%Q/Q. And with GDP also stronger than previously estimated in the first two quarters of the year, this left output 1.7% higher compared with a year earlier, the strongest annual pace since 2017. The improved performance in Q3 in part reflected stronger growth in household consumption, revised up by 0.2ppt to 0.5%Q/Q, although this was still considerably weaker than the surge in spending seen in Q114 before the previous consumption tax hike. Private non-residential investment was also firmer than initially estimated, with the 1.8%Q/Q increase double the rate of growth in the preliminary release to provide the largest contribution to GDP growth in (0.3ppt). But while private inventories were also revised higher, they still provided a drag on growth (-0.2ppt). Net trade also remained a drag on growth with the negative contribution unrevised at -0.2ppt.

Overall, today’s release still suggested that the front-loading of spending ahead of October’s consumption tax hike was more restrained than in 2014. But while the first insights into economic activity in October suggest that the initial drop in demand was just as large (see the latest Yen 4Sight for more details), November releases have on the whole been a touch more encouraging. And, at face value at least, today’s economy watchers survey tallied with the PMIs that month signalling a pickup in demand, with the headline index up 2.7pts in November to 39.4 and a 4½pt increase registered in the household-related demand DI. The overall outlook index also rose to a five-month high (45.7) to signal stronger growth ahead. Admittedly, however, today’s survey disappointingly reported a further decline in the corporate-related demand DI on the back of renewed weakness in manufacturing – indeed, the manufacturing DI fell its lowest level since the aftermath of the 2011 quake.

The second half of the week will bring more insight into business conditions in Q4, with the MoF's latest business sentiment survey – due on Wednesday – set to provide firms’ first projections for conditions in H120. This will be followed on Thursday by the monthly Reuters Tankan indicators for December, as well as machine orders figures for October. But of most interest – and of most relevance to BoJ Policy Board makers ahead of next week’s meeting – will be Friday's comprehensive quarterly BoJ Tankan, which will report a deterioration in conditions in the manufacturing and non-manufacturing sectors in the final quarter, but also expectations of modest recovery in the New Year. Thursday will also bring the latest machine orders figures for October. In the markets, the MoF will sell 5Y JGBs tomorrow.

Euro area:
The main event in the euro area this week will be Thursday’s conclusion of the latest ECB Governing Council meeting, the first since Christine Lagarde succeeded Mario Draghi as President. The meeting will coincide with publication of the ECB’s updated macroeconomic projections. But we do not expect significant amendments to be made to the previous projections, published in September, which anticipated a gradual pickup in GDP growth and inflation over coming quarters. At the October meeting, some Governing Council members cautioned that the expected improvements might not materialise. However, euro area GDP growth in Q3 (0.2%Q/Q) was a touch firmer than the ECB had expected and the near-term profile for inflation is likely to be slightly stronger than previously forecast.

This time around, the ECB will for the first time publish projections for 2022, which we expect to show inflation below but close to 2.0%Y/Y, essentially consistent with its target, in that year. But Lagarde is likely to emphasise that the risks to the outlook remain skewed to the downside. So, there will be no reason whatsoever to amend policy, including the forward guidance which currently states that “the Governing Council expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon and such convergence has been consistently reflected in underlying inflation dynamics”. Of course, Lagarde has already indicated that the ECB will shortly commence a review of its monetary policy strategy, and her press conference on Thursday might offer detail on its scope, direction and timeline.

Data-wise, following Friday’s weak industrial production data for October, Germany’s export data for the same month – released earlier this morning – provided a welcome upside surprise. Contrary to expectations of a slight decline on a year earlier following growth of 1.5%Y/Y (the most in almost two years) in September, German export values rose a firm 1.2%Y/Y. That left them up 0.8%3M/3M, the most on a three-month basis since February. Growth in the value of exports to the euro area fell 0.9%Y/Y, but it was firmer to non-euro area EU member states (up 1.7%Y/Y, probably led by the UK ahead of the Article 50 deadline) and to non-EU countries (4.6%Y/Y). Import values, meanwhile, were flat on the month to leave them up just 0.3%3M/3M. And so the trade surplus increased €1.4bn to €20.6bn, the highest so far in 2019. According to Bundesbank data adjusting for price effects, export volumes rose 1.3%M/M for a second successive month while import growth eased to just 0.2%M/M in October following growth of 0.5%M/M the previous two months, to suggest that net trade continued to provide support to German economic growth, having contributed 0.5ppt to growth in Q3.

This morning has also brought the Bank of France’s latest business sentiment survey. But while this signalled a modest improvement in services – the headline index rose 1pt to 99 – there was similar decline the equivalent manufacturing index (down to 97) as production in the sector reportedly stabilised that month. And with construction activity having also weakened, the Bank of France assessed today’s survey to be consistent with GDP growth of 0.2%Q/Q in Q4.

Focus will remain on the manufacturing sector for the remainder of the week, with French and Italian IP figures for October due tomorrow, and the equivalent euro area data due on Thursday, which are expected to show aggregate IP declined at least ½%M/M at the start of Q4. Other data due this week include the ZEW survey of investor sentiment in December tomorrow.

In terms of politics, strains within the Italian government coalition will remain closely watched, with disagreements last week having emerged over the 2020 Budget plan, which was criticised by European Commission Vice President Dombrovskis. Not least given the likelihood that any early election would be won comfortably by Salvini’s League and its allies, we do not expect the government to fall apart over the near term, and certainly not before the regional elections due in late January. In the markets, Germany will sell 2Y Schatz tomorrow, and Italy will sell 3Y and 7Y BTPs on Thursday.

Of course, all eyes in the UK will be firmly on Thursday’s General Election, with markets likely to respond to the exit polls published as soon as polling stations close at 10pm. The results from individual constituencies will be published throughout the night, with the overall result likely to be clear well before European markets reopen on Friday morning. In the past week, investors have firmed up their expectation of a Parliamentary majority for PM Johnson’s Conservatives, as opinion polls suggest that the party’s lead over Labour has stabilised at around 10ppts. Given the margins of error on these polls, however, it remains within the bounds of possibility that the Conservatives will fall short of a majority, which would then open the door to a minority Labour administration. We currently attach a probability of 75% to a Conservative majority.

A majority for the Conservatives would mean that the UK would leave the EU at end-January and then enter a Brexit ‘implementation’ phase, which Johnson insists would conclude at the end of 2020. However, as it would be difficult for a new Free Trade Agreement between the UK and EU to be agreed and ratified before then, the risk of a highly costly WTO exit – implying the imposition of tariffs and non-tariff barriers to trade – at the end of next year would persist. The associated uncertainty would thus continue to weigh on business investment, which has flat-lined since the 2016 referendum. And so we would expect UK GDP to remain very subdued, meriting an easing of monetary policy. Therefore, while a Conservative majority would likely to see sterling appreciate further and Gilt yields rise too, we would expect those effects to reverse once again in the New Year as the continued weakness of economic activity became evident.

If there is a minority Labour administration, the new Government would need to seek a further extension of the Article 50 deadline beyond end-January to accommodate a second Brexit referendum around mid-year. It would also try to rapidly negotiate an alternative softer Brexit deal to be subjected to that referendum. The near-term impact on sterling and Gilt yields would be negative, and the near-term economic outlook would be no better as uncertainty persists. However, the possibility that Brexit might eventually be cancelled would represent upside future potential for sterling and economic growth.

Data-wise, all of the top-tier UK releases will come tomorrow, with the October figures for GDP, production and trade due. The consensus forecast is for growth of 0.1%M/M, which would leave three-month growth at just 0.1%3M/3M. We see the risks to that view as skewed to the downside. Not least given the impact of uncertainty ahead of the end-month Article 50 deadline, manufacturing production seems likely to post a third successive monthly decline, while construction output is also likely to fall. Growth in services will likely be minimal. So, the difference between growth and stagnation might come down to the North Sea oil and gas sector. The only other data release of note will come on Thursday with the November RICS residential market survey. In the markets, the DMO will sell 30Y linkers on Wednesday.

Like in the euro area, monetary policy will also be the focus in the US, where the Fed’s latest policy meeting will conclude on Wednesday. No change to policy is expected, with the target range for the Fed Funds Rate to be maintained at 1.50-1.75%. And there seems little reason for Powell to change his recent message that rates are likely to be left unchanged for a while to come. Nevertheless, there will be scrutiny of FOMC members’ updated economic projections and dot-plots of the expected path of rates, with the latter likely to highlight again the Committee’s bi-directional split.

It will be a quiet start to the week for US economic data, with no releases scheduled today and the NFIB small business survey for December and final Q3 unit labour cost and productivity data due tomorrow. Thereafter, a key focus will be inflation, with November’s figures for CPI, PPI and import/export prices due Wednesday, Thursday and Friday respectively. In terms of CPI, both the headline and core indices are expected to rise 0.2%M/M, which would see the headline annual rate rise 0.2ppt back to 2.0%Y/Y but the core rate unchanged at 2.3%Y/Y. The other top-tier release of the week will come on Friday with the advanced retail sales figures for November. In the markets, the Treasury will sell 3Y Notes today, 10Y Notes tomorrow and 30Y Bonds on Thursday.

China’s export data for November missed expectations, falling 1.1%Y/Y in USD terms following a drop of 0.8%Y/Y the prior month to remain down 1.7%3M/Y. Exports to the US fell 23.0%Y/Y, the most since February, while shipments to Japan were down 7.8%Y/Y and those to the EU were down 3.8%Y/Y. In contrast, exports were up 0.5%Y/Y to South Korea and a strong 18.0%Y/Y to ASEAN countries. Imports, however, rose in USD terms for the first time since April, albeit up just 0.3%Y/Y to leave them down a still hefty 4.8%3M/Y. Imports from the US were up 2.7%Y/Y – the first positive showing since August 2018 – while shipments from the EU were up 2.6%Y/Y but those from Japan were little changed (down 0.1%Y/Y).

Looking ahead, tomorrow will bring China’s inflation figures for November, which are expected to show a further tick up in the headline CPI rate to above 4.0%Y/Y for the first time since January 2012 on the back of higher pork prices. Core inflation, however, is likely to remain little changed from 1.5%Y/Y in each of the prior three months. And, most notably perhaps, producer prices are likely to illustrate continued disinflationary pressures down the pipeline, with a consensus forecast for a drop off 1.5%Y/Y (from -1.6%Y/Y in October). November’s new loan data are also due for release sometime this week.

After a quiet start to the week for Australian economic news, tomorrow will bring the latest NAB business confidence survey for November, as well as official house price figures for Q3, of which the latter is expected to mirror the recent uptrend seen in monthly price figures to show a notable increase over the quarter as a whole of around 3½%Q/Q. These will be followed on Wednesday by the Westpac consumer confidence survey for December.

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