Japanese data disappoint

Chris Scicluna

While the S&P500 ended yesterday up just shy of 1.0% at a new closing high, the positive mood was upset by reports in the NY Times that Donald Trump had approved military strikes against Iran before eventually pulling back. With US futures pointing lower, Japanese equities led the declines in Asia, with the Topix closing down 0.95% on the day as the yen edged higher, and Japan’s latest economic data suggested that inflation has peaked while manufacturing sector weakness persists. Elsewhere, the moves were more moderate, e.g. Korea’s Kospi was down 0.3% while markets in China and Taiwan made modest gains.

In fixed income markets, having lost a little ground yesterday, USTs made only modest gains in Asian time (e.g. 2Y yields are currently back close to 1.75% while 10Y yields are back down to 2.00%). And after Kuroda yesterday said that his 10Y yield target range (+/-0.20%) should be interpreted flexibly, JGBs also made edged higher (10Y yields edged down 1bp to -0.18%) as the BoJ failed to reduce its purchases at its latest Rinban operation. In Europe, however, equity markets and bond yields have opened higher with the flash June PMIs for Germany and in particular France surprising on the upside to suggest some improved momentum at end-Q2.

While the BoJ yesterday maintained its assessment that the economy continues on a moderate expanding trend and that underlying inflation is heading gradually towards its 2% target, today’s economic data – May’s national inflation figures and the flash June manufacturing PMIs – suggested otherwise.

As expected, Japanese inflation slipped back in April on all key measures. While consumer prices overall were unchanged on a seasonally-adjusted basis, base effects saw the annual headline inflation rate decline 0.2ppt from April’s six-month high to 0.7%Y/Y. And with food prices having risen over the month, all core indices fell 0.1%M/M to push the repective annual rates lower too. So, the annual core CPI (excluding fresh food prices) measure used in the BoJ’s forecasts fell 0.1ppt to 0.8%Y/Y. Stripping out energy too, the BoJ’s preferred core inflation measure fell 0.1ppt from April’s three-year high to 0.5%Y/Y. And excluding all food and energy prices, the core measure which aligns most closely with those reported by other major economies fell 0.2ppt to a paltry 0.3%Y/Y.

The decline in inflation was widely anticipated as the temporary boost to prices in April related to the extended Golden Week holiday seemed bound to reverse last month. Indeed, having added almost 0.1ppt to inflation in April, recreational services subtracted the same amount in May, as inflation of hotel charges fell 4ppts to -0.2%Y/Y and package tour inflation fell 8.5ppts to 6.6%Y/Y. Overall, services inflation rose 0.2ppt to a three-month high of 0.5%Y/Y, but inflation of non-energy industrial goods fell back 0.1ppt to 0.4%Y/Y. Meanwhile, a drop of more than 2ppts in household energy inflation to an eight-month low of 3.6%Y/Y also subtracted 0.1ppt from inflation.

Looking ahead, there seems every reason to expect core inflation to move lower over coming months. Base effects mean that energy prices are likely to subtract from annual rates. The introduction of free early childhood education from October will neutralise much of the upwards pressure on CPI from the consumption tax hike. And government efforts to reduce mobile phone charges – e.g. with the MIC this week stating that it will require operators to cut cancellation fees by 90% from the autumn – will also weigh. So, a further decline in the BoJ’s forecast core CPI measure to below ½%Y/Y over coming months seems highly likely. And underlying weakness might seem likely to persist into the New Year as and when economic activity contracts after the consumption tax is hiked.

The flash manufacturing PMIs were also disappointing, with the headline index falling 0.3pt to a three-month low of 49.5 to suggest ongoing weakening of momentum in the sector. The detail, however, was not all bad news, with the output index up 0.9pt to 49.6, the highest level this year, to hint at a stabilisation of production. However, the new orders index points to deterioration ahead, falling 1.3pts (the most since January) to a three-year low of 47.3, with the measure of new export orders down by a similar magnitude to a five-month low of 46.4. Perhaps reassuringly, the survey’s employment index ticked up slightly, albeit still near the bottom of the range of the past three years at 51.1. And disconcertingly for the BoJ, the output price PMI fell almost 3pts to a near-three-year low of 48.9, suggesting falling prices in the sector for the first time since the end of 2016. 

Euro area:
The most notable euro area economic data of the week are out today in the shape of the flash PMIs for June. And the news so far is better than expected. Most notably, the French indices for manufacturing and services alike surprised on the upside to suggest an improvement in momentum at the end of Q2, with the former up 1.4pts to a nine-month high of 52.0 and the latter up 1.6pts to a seven-month high of 53.2. That left the French composite PMI also at a seven-month high (54.2). It does not, however, make us want to change our latest French GDP forecast of 0.2%Q/Q in Q2.

Germany’s indices suggested more limited improvement. Most notably, the manufacturing PMI rose 1.1pts to a four-month high, but at 45.4 still signalled significant contraction in the sector, with the output index little changed. And the services PMI rose just 0.2ppt to 55.6, to leave the composite index unchanged at 52.6. Again, given these numbers, we do not feel the need to change our GDP forecast for the euro area’s largest member state of just 0.1%Q/Q, down from 0.4%Q/Q in Q1.

While the picture in Southern Europe is unclear, the German and French results suggest that the euro area indices, due shortly, are likely to post modest improvement from May’s readings (manufacturing PMI at 47.7 and services PMI at 52.9).

It is set to be a relatively low-key end to the week for UK economic news, with May’s public finances data the only notable new release. Like over the past few months, these are again likely to show public sector net borrowing close to the level for the same month last year, in this case £3.2bn (or £4.1bn excluding public sector banks). Of course, with the remaining candidates in the Conservative party leadership campaign having promised fiscal giveaways on both tax and spending sides, and flirted with the idea of a no-deal Brexit, the risks to public sector borrowing over the coming couple of fiscal years appear skewed to the upside regardless of today’s data.

In the US, an eventful week will conclude with just existing home sales data for May and the flash Markit PMIs.


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