RBA cuts as German sales dip

Chris Scicluna
Emily Nicol

While yesterday’s rally pushed Wall Street to new highs, the publication by the US Trade Representative’s office of a list of $4bn of goods from the EU that might face increased tariffs provided a reminder that Trump’s trade wars haven’t gone away. Yesterday’s economic dataflow was hardly inspiring either, with the Markit global manufacturing PMI declining for the 14th consecutive month to the lowest level in 6½ years to provide a reminder of the toll that the trade wars are taking on the world’s industrial sector. And so, with no new game-changing economic data from the region today, momentum in Asian equity markets appeared largely to have dissipated.

In particular, with the yen broadly steady, Japan’s Topix closed up 0.3%, as the BoJ’s Tankan of firms’ price expectations suggested that its inflation target continues to lack credibility (detail below). And China’s CSI300 was little changed. In contrast, having missed out on yesterday’s rally amid the renewed demonstrations, the Hang Seng opened higher today, and is currently up about 1.2% on the day. In Australia, however, the ASX closed up just 0.1% weighed by financials, the AUD firmed a touch, and ACGBs were little changed (10Y yields still just above 1.33%) as the RBA cut its cash rate to a new record low of 1.00% and signalled the likelihood of further easing ahead.

In Europe, meanwhile, equities have opened with a mix of small gains and losses but bonds are a touch firmer. And BTPs have made substantive further gains (10Y yields down 7bps to below 1.90% for the first time in more than a year) on reports that the government will reinstate its budget deficit target of 2.04% of GDP for this year, having previously revised it up to 2.4% to the ire of the European Commission.

Data-wise, Germany’s latest retail sales report, released earlier this morning, added to evidence of a subdued second quarter. And attention will soon move back to EU leaders, who are set to reconvene later this morning to try to agree whom to nominate to be the next heads of the institutions. While the decision-making is currently blocked by an impasse over Juncker’s successor at the Commission, the identity of whom to follow Draghi at the helm of the ECB is obviously what matters for markets. Reports that a French woman (IMF MD Lagarde most likely, or perhaps even OECD Chief Economist Boone) is now in pole position would suggest the likelihood of broad continuity from the pragmatic Draghi era. But in the event that the job goes to an obvious hawk (the Bundesbank’s Weidmann, and to a lesser extent the Netherlands central bank chief Knot, who yesterday belatedly tried to paint himself as dovish) markets would be entitled to respond by pushing the euro, bond yields and BTP spreads significantly higher.

Today the BoJ released further details from its latest Tankan survey, with most notably information on firms’ inflation expectations. While firms continued to indicate that they are unconvinced that the BoJ will achieve its 2% inflation target, even within a 5-year horizon, there was at least limited evidence that firms’ scepticism had strengthened as a result of their more downbeat assessment of the economic outlook. For all firms, the average expectation of inflation one year ahead remained at just 0.9%Y/Y, while firms’ average expectation at the three-year horizon was revised slightly lower to 1.0%Y/Y and at the five-year horizon unchanged at just 1.1%Y/Y. Large firms were admittedly more sceptical about the inflation outlook across the horizon, with manufacturers and non-manufacturers alike expecting inflation of just 0.7%Y/Y five years ahead, almost half the rate anticipated when the survey began at the start of 2014.

As usual firms’ expectations regarding their own output prices remained even weaker. And over the near term they were more downbeat than three months ago, forecasting a rise in prices over the coming year of just 0.7%Y/Y, down 0.1ppt from the previous survey. The outlook further ahead was unchanged, forecasting a cumulative increase of 1.2% and 1.5% over the next three and five years respectively. Admittedly, larger firms were slightly less pessimistic about prices than three months ago, although manufacturers were still forecasting a cumulative decline in prices over the coming five years of 0.3%. And large non-manufacturers expected a cumulative increase of a little more than 1% over the same horizon. In contrast, smaller firms remained more upbeat about the outlook for their own output prices, with manufacturers forecasting a cumulative rise of 1.6% over the next five years, while non-manufacturers expected a rise of more than 2%.

Euro area:
We have already seen the release of today’s most noteworthy new data from the euro area, with German retail sales figures for May falling short of expectations. Contrasting with an expected increase, sales declined for the second successive month and by 0.6%M/M. And while the drop in April was less severe than initially estimated, sales were still down a hefty 1%M/M. Nevertheless, to some extent reflecting the steady growth over the past year, sales were still up an impressive 4%Y/Y in May, with spending on food up more than 2½%Y/Y, non-food sales up more than 5%Y/Y and internet and mail order purchases up more than 8%Y/Y.

Those annual rates were flattered to some extent by the additional working day this year compared with last. Indeed, today’s release clearly suggested that household consumption has weakened considerably after a surge in the first quarter of the year – in the first two months of Q2, retail sales were 1% lower compared with the average in Q1. And this further supports our view that the boost to GDP at the start of year won’t be repeated in Q2, with our forecast for economic growth to moderate to 0.1%Q/Q from 0.4%Q/Q in Q1.

Not unexpectedly, the RBA today cut its cash rate by 25bps for the second month in succession to a new low of 1.00%. The move represented its first back-to-back easing of monetary policy since 2012. The post-meeting statement by Governor Lowe was little changed from last month. Indeed, there were no amendments whatsoever made to the key final paragraph, which thus re-emphasised the importance of developments in the labour market and made clear that the Board will ease policy again if needed.

In terms of its assessment of economic conditions, Lowe’s statement acknowledged that GDP growth in the year to Q1 had been below-trend, weighed among other things by low income growth and declining house prices. The RBA still expects a pickup in activity in the resources sector and also sees tentative signs that house prices in Sydney and Melbourne are now stabilizing. But given, among other things, slower growth in Asia, it judges that its central scenario, whereby growth over the coming couple of years is merely broadly around trend, remains reasonable.

As such, while Lowe’s statement made clear that the RBA’s rate cuts “will help make further inroads into… spare capacity”, demand currently seems unlikely to be sufficiently vigorous to achieve the above-trend growth required to push the unemployment down significantly, and push wage growth and underlying inflation higher. Like all major central banks, the RBA is also well aware that the risks to global demand are skewed significantly to the downside. And as Lowe has recently noted, the Bank will likely get less bang for its buck from easing monetary policy at a time when the other major central banks are cutting rates too, not least given the diminished impact on exchange rates (as illustrated by the appreciation of the AUD through the back end of last month). So, further easing seems inevitable, with another 25bps cut on 6 August a good bet, particularly if the Fed moves at the end of this month. Further insights might be given by Governor Lowe when he speaks publicly about policy in Darwin in a couple of hours’ time.

After yesterday’s extremely weak June manufacturing PMIs, today will bring the equivalent survey for the construction sector. Given ongoing uncertainties surrounding the Brexit outcome and recent housing market weakness, the headline construction index is likely to have remained below the key-50 expansion level for the fourth month out of the past five in June. Meanwhile, in the markets, the DMO will issue 5Y Gilts.

The Nationwide house price index for June, released earlier this morning, showed that residential property price growth remained subdued at the end of the second quarter, up just 0.1%M/M and 0.5%Y/Y, broadly in line with rates seen earlier this year and well down those of recent years. Once again the weakness in the second quarter was driven principally by London and the South East, with prices in the capital down compared with a year earlier for the eighth consecutive quarter. Annual price growth elsewhere in England was still modest, on aggregate broadly little changed compared with a year ago. In contrast, the housing market in Northern Ireland again outperformed in Q2, with prices up more than 5%Y/Y, while house prices rose more than 4%Y/Y in Wales. Not least given persistent uncertainties surrounding Brexit, we would anticipate activity in the UK housing market on aggregate to remain subdued over coming quarters, with price declines in London and the South East likely to continue to drag down the national average.

In the US, it should be a relatively quiet day with the June vehicle sales the only notable new data release. However, NY Fed President John Williams will speak publicly on the global economic and monetary policy outlook.


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