Morning comment: Japanese IP, German retail sales & Brexit

Chris Scicluna
Emily Nicol
Mantas Vanagas

After rallying on Wednesday, US and euro area bond markets were slightly weaker on Thursday despite generally disappointing data across both markets (including a downgrade to Q4 GDP in the US and softer-than-expected inflation reports in Germany and Spain). With the US 10Y Treasury yield drifting back up to 2.38% the S&P500 eventually closed up 0.4%, near the top of the day’s trading range. The US dollar was also slightly firmer, particularly against sterling.

In Asia, equity markets have ended the week and quarter on a positive note today. This is especially so in China where, ahead of the release of the official PMI reports for March on Sunday, the CSI300 increased a bumper 3.9%, taking its advance for the quarter to 29%. Sentiment was buoyed by US Treasury Secretary Mnuchin’s remark that officials had a “very productive” working dinner on Thursday evening, adding that he was looking forward to today’s meetings. In Japan, a volatile week ended with the TOPIX gaining 0.6%, lifting its advance for the quarter to 6.5%. A very busy day for domestic data – discussed in detail below – produced a few offsetting surprises, leaving JGB yields little changed on the day. Benchmark indices rose about ½% in Singapore and South Korea. In the Antipodes the ASX200 edged only slightly higher with ACGB yields lifting off yesterday’s lows (10Y yields up 5bps to 1.78%) as investors looked ahead to next Tuesday’s RBA Board meeting and Federal Budget release – the latter likely to contain some pre-election sweeteners. Bond yields also increased in New Zealand, assisted by signs of resilient consumer confidence and another positive building approvals report, even as RBNZ Governor Orr indicated that he was content with this week’s market moves.

Moving to Europe, the day has got underway with some upbeat German retail sales data, which point to solid growth in consumption in Q1. But French inflation figures missed expectations adding to evidence of a decline in euro area inflation this month. Looking ahead, US personal spending figures will provide the day’s data highlight, while all eyes in the UK will be on the House of Commons, where Theresa May is set for yet another humiliating defeat, which – for the time being at least – will bring forward the Article 50 deadline to 12 April. Details on this and more below.

An extremely busy day in Japan has seen the release of a large number of economic reports covering developments in both activity and prices.

The main focus has been the IP report for February, especially in light of the 3.4%M/M slump in output that took place in January. As it turns out, output rebounded an unimpressive 1.4%M/M in February – nonetheless, an outcome that was in line with market expectations and a little firmer than METI had figured last month after adjusting firms’ forecasts to remove the usual optimistic bias. As a result, output was still down 1.0%Y/Y.

Within the detail, production of capital goods rebounded 4.6%M/M in February following an 8.5%M/M decline in January, but was still down 3.1%Y/Y. In a similar vein, production of durable consumer goods rebounded a more impressive 9.2%M/M following a 7.1%M/M decline in January, but was still down 0.3%Y/Y. Production of non-durable consumer goods again bucked the trend with a 1.4%M/M decline in February, but was still up 4.1%Y/Y. With respect to the key export-oriented sectors, despite an improvement during the month output of production machinery was still down 5.6%Y/Y in February, while production of electronic parts and devices fell a further 3.7%M/M and was down 9.6%Y/Y. Production of electrical machinery and ICT equipment fell 4.2%Y/Y, while production of motor vehicles grew a negligible 0.1%Y/Y.

Elsewhere in the report, aggregate shipments increased 1.8%M/M in February. This erased only about half of January’s 3.4%M/M decline, so shipments were still down 0.3%Y/Y. As with the increase in production, the rebound in shipments in February was driven by capital goods and consumer durable goods. Inventory levels, which have been a concern in some parts of the industrial sector, increased an unwelcome 0.5%M/M in February and remained up 1.4%Y/Y. Inventories of construction goods rose 3.4%Y/Y, whereas inventories of capital goods rose 1.4%Y/Y. In the electronic parts and devices sector, inventories rose 27.1%Y/Y despite the cutback in production. The overall inventory-shipments ratio fell 0.2%M/M in February but was up 2.0%Y/Y – an outcome that would not typically bode well for production, at least in the near term. Over the past year the inventory-shipments ratio has declined in the non-durable consumer goods and construction goods sectors, but increased elsewhere.

In describing the performance of the sector, METI chose to retain last month’s downgraded assessment that “Industrial production is pausing”. Judging by the latest survey of manufacturers, that assessment remains somewhat generous. While in aggregate firms forecast a further 1.3%M/M increase in activity in March – up from the 1.6%M/M decline that was forecast last month – firms’ forecasts tend to be too optimistic. Even if this forecast proves accurate, and assuming no revisions, industrial output will decline about 2.5%Q/Q in Q1, marking the worst quarter since Q312. Correcting for the usual over-optimistic bias, METI expects firms’ forecast to translate into a mere 0.4%M/M increase in March, which would leave output down an even greater 2.8%Q/Q. Such an outcome would not be at odds with the weak manufacturing PMI readings seen during the quarter. At this stage, firms have forecast a further 1.1%M/M lift in output in April, but we would treat that forecast with even greater caution.

Moving on, today METI also released news on retail sales during February. Unfortunately spending increased just 0.2%M/M – much less than the market had expected but broadly in keeping with our retail sector analyst’s reading of the reports issued by the major retailers. The disappointment was partly mitigated by an upward revision to spending in January, which now fell 1.8%M/M rather than the 2.3%M/M slump that was first reported. Even so, annual growth slowed unexpectedly to just 0.4%Y/Y from 0.6%Y/Y previously. While spending on general merchandise rose 1.6%M/M, spending on household machines fell 1.9%M/M and spending on food and beverages fell 1.0%M/M. And after declining 2.5%M/M in January, spending on motor vehicles was unchanged in February. Given today’s result, average retail spending over the first two months of Q1 is running 1.5% below that recorded through Q4. Fortunately, the retail sales figures are not the best indicator of private consumption, which is unlikely to be as weak as that. A better gauge will come next Friday when the BoJ will release the Consumption Activity Index for March, while the Cabinet Office’s Synthetic Consumption Index will likely make an appearance a week or so later.

Turning to the construction sector, MILT reported that the number of housing starts rebounded 10.9%M/M in February, reversing the 9.3%M/M slump recorded in January. This outcome was stronger than the market had expected and caused annual growth to increase to 4.2%Y/Y from just 1.1%Y/Y previously. Even so, the average number of starts over January/February combined was 3.8% below the average level recorded through Q4. And should the higher February level be maintained in March, starts will still be down about 2%Q/Q in Q1. Meanwhile, Japan’s largest contractors reported that construction orders fell 3.4%Y/Y in February, providing some payback following the 19.8%Y/Y increase reported in January. Over the last three months combined, construction orders rose 2.5%Y/Y, with private orders up 6.5%Y/Y but government orders down 10.5%Y/Y.

On a brighter note, the household labour market survey pointed to surprising strength in February. After declining over the previous two months – seemingly consistent with the downbeat tone of most other activity indicators – employment was reported to have increased 490k in February, thus almost entirely erasing those declines. Given the volatility it is probably best to draw a thick line through these figures and thus simply note that employment was little changed over the 3-month period as a whole. Annual growth in employment stood at a solid 1.2%Y/Y in February – strong considering that overall economic activity has grown only marginally over the past year. This is consistent with other indicators that continue to point to increased demand for labour input – demand that firms have struggled to satisfy given very tight labour market conditions. Compared with a year earlier the largest lift in employment occurred in the healthcare/welfare and IT/ telecommunications sectors, whereas the wholesale/retail and manufacturing sectors were the largest drag (manufacturing employment fell 1.3%Y/Y). The employment rate (i.e. the proportion of the working-age population in employment) rebounded 0.3ppt to 60.0% in February, thus returning to where it had closed out last year.

With the labour force participation rate rebounding 0.2ppt to 61.4% – also erasing its January decline – the labour force increased 340k in February and was up 1.0%Y/Y. But given the even larger rebound in employment, the unemployment rate still fell an unexpected 0.2ppt to 2.3%. This returned the unemployment rate to the cyclical low reached briefly in May last year (and before that, last seen in 1993). That decline was driven by the female unemployment rate, which fell 0.3ppt to 2.2%, whereas the male unemployment rate was steady at 2.5%. Separately, the MHLW reported that the effective job offer-to-applicant ratio remained steady at 1.63x for a fourth consecutive month in February – just below the four-decade high recorded back in September. The number of outstanding job offers fell 0.2%M/M, lowering annual growth to 0.6%Y/Y. However, the number of new job offers rose 0.7%M/M and 2.1%Y/Y – this contrasting with a 0.1%M/M and 3.6%Y/Y decline in the number of new job applicants. So in summary, while employment appears to have been little changed in recent months – probably reflecting both demand and supply side factors – the labour market remains very tight. The BoJ will continue to hope this provides the catalyst for higher wage growth and inflation over time.

On that score, the advance CPI for the Tokyo area for March provided no surprises, with all of the key aggregates printing exactly in line with market expectations. The seasonally-adjusted headline index was unchanged for a second consecutive month but base effects caused annual inflation to rise 0.3ppt to a 5-month high of 0.9%Y/Y. The price of fresh food fell a further 2.8%M/M in March and was down 4.5%Y/Y. Even so, after seasonal adjustment, the ‘BoJ forecast’ core index (which excludes fresh food) was weaker than the headline index, declining 0.1%M/M but leaving annual inflation steady at 1.1%Y/Y for a third consecutive month. And while energy prices rose 0.6%M/M, the BoJ’s preferred measure of core prices – which excludes both fresh food and energy – also fell 0.1%M/M in March, leaving annual inflation on this measure steady at 0.7%Y/Y.

As far as other key aggregates are concerned, after excluding fresh food, annual goods inflation picked up 0.2ppt to 1.9%Y/Y, while inflation in prices for industrial products also picked up 0.2ppt to 0.8%Y/Y. However, inflation in the service sector – which one might have hoped would pick-up given persistent extreme tightness in the labour market – declined 0.2ppt to a 4-month low of 0.6%Y/Y. Attention will now turn to the various inflation indicators contained in next week’s BoJ Tankan survey. But overall, today’s figures did little to alter our view about the near-term inflation outlook, with the nationwide measure of core CPI (ex fresh foods) likely to edge lower in Q2 as energy price inflation becomes a greater drag to just ½%Y/Y around the middle of the year.

All eyes today will be back on the House of Commons for another Brexit debate and vote, the latter of which is set to be conducted shortly after 2.30pm GMT. On what she had hoped to be Brexit Day, Theresa May is asking MPs to vote to approve her Withdrawal Agreement, this time without the accompanying Political Declaration on the future relationship, to meet the conditions set by European leaders to allow the UK to leave the EU on 22 May. But with the Northern Irish DUP still vehemently opposed, at least 25 Conservative Brexiters similarly set to vote against, the Labour frontbench unwilling to accept the ‘blindfold Brexit’ that the lack of agreement on the Political Declaration would imply, and Labour rank-and-file MPs from Leave-voting constituencies alienated by May’s evident determination to put her party before her country, we fully expect the PM to be defeated once again, perhaps by upwards of 50 votes.

Given the parliamentary arithmetic, the motivations of Theresa May for even calling today’s vote are somewhat mystifying. Nevertheless, defeat will confirm that the Article 50 deadline will, for the time being, be automatically brought forward to 12 April, although a special EU summit on 10 April would likely push back the deadline by several months, to the end of this year or beyond. And the process of indicative votes being held by MPs on various options will then resume on Monday in order to secure that lengthier extension.

Ongoing Brexit uncertainty is unsurprisingly taking its toll on the UK economy. According to the the GfK survey released this morning, consumer confidence remained little changed at a subdued level this month, with the headline indicator moving sideways at -13, just 1pt above the readings seen around the turn of the year, but significantly below its average of recent years. Consumers remained concerned about the current state of the UK economy and its outlook. Although the relevant indicator for the latter edged slightly higher for a second consecutive month, it was still at one of the lowest levels since the global financial crisis. Consumers’ assessment of their personal financial situation was also little changed from the previous month, but the climate for major purchases deteriorated, having shown an improvement to a five-month high in February.

Overall, the survey signalled a small deterioration in consumer confidence in Q1 as a whole. But with January and February’s retail sales figures having outperformed expectations, we continue to expect that household consumption growth this quarter will have maintained the 0.4%Q/Q pace seen in Q4. One source of concern for UK consumers might be the housing market. With several recent indicators having suggested a deterioration in conditions, the Nationwide index, also released this morning, reinforced that message. Although prices rose 0.2%M/M this month to leave the annual pace edging slightly higher to 0.7%Y/Y, they fell 0.1%Q/Q in Q1 for a second quarter in a row. In terms of business sentiment, meanwhile, this morning’s Lloyds Business Barometer survey was not particularly positive either, with the survey’s headline index rising only slightly from the seven-year low of 4% in February to 10% in March.

Euro area:
A busy day for economic data from the euro area has already brought a positive surprise from German retail sales, which rose 0.9%M/M in February following growth of 2.8%M/M in January, to leave them more than 4½% higher than year earlier. While food sales were up more than 2%Y/Y, spending in non-food stores was much stronger at 6.1%Y/Y in February, of which online sales rose more than 9%Y/Y. So, over the first two months of the year, sales were on average almost 2% higher than the average in Q4. And coupled with some improved car registration data, these figures suggest that, despite the recent drop in confidence, German household consumption will provide a boost to GDP growth in Q1. In contrast, French consumer spending on goods came in on the soft side in February, declining 0.4%M/M to leave it down 1.8% compared with a year earlier. However, the weakness in February followed upwardly revised growth in January (1.4%M/M), to leave spending on goods on average so far in Q1 0.2% higher than in Q4.

The latest news on inflation, however, will have been more disappointing for the ECB. Like yesterday’s German figure, the flash harmonised CPI estimate from France fell more than expected in March, by 0.3ppt to 1.3%Y/Y, a thirteen-month low. A drop of 0.2ppt was recorded in the national headline measure to 1.1%Y/Y, despite an increase of 2.1ppt in energy inflation, with services inflation on this basis down 0.3ppt to just 0.6%Y/Y, while the pace of decline in manufactured goods inflation was unchanged at 0.5%Y/Y. So, like in Germany, core inflation in France seems bound to have eased this month too. Later this morning will bring the equivalent figures from Italy, which are expected to report a drop of 0.1ppt in the harmonised rate to 1.0%Y/Y, which would add to evidence of a step down in euro area inflation at the end of Q1.

In the US, today will bring data for personal spending in January – which seems unlikely to fully reverse the 0.5%M/M drop in December – along with the core PCE deflator for that month and personal income data for February. New home sales data for February, the final results of the University of Michigan’s consumer survey for March and the Chicago PMI for March are also due. In addition, the Fed’s Kaplan and Quarles are due to speak publicly.

As usual the end of the month saw the RBA release its money and credit aggregates, in this case pertaining to February. Private sector credit increased 0.3%M/M – the most since November – but annual growth still declined 0.1ppts to a 5-year low of 4.2%Y/Y. Housing credit also rose 0.3%M/M and 4.2%Y/Y, weighed down by investor housing credit which was flat in the month and up just 0.9%Y/Y (housing credit to owner occupiers rose 5.9%Y/Y). Other personal credit fell 0.1%M/M in February and was down 2.7%Y/Y, but business credit rose 0.3%M/M and 5.3%Y/Y.

New Zealand:
Following on from yesterday’s more pessimistic ANZ Business Outlook survey, the ANZ-Roy Morgan survey of consumers pointed to a modest improvement in confidence during March. The headline index rose 0.8%M/M to 121.8, leaving it slightly above its long-term average and close to the average reading recorded through last year. The component indices pointed to an improvement in respondents’ optimism about the longer-term economic outlook, while a robust net 38% of respondents held the view that it is a good time to buy major household items.

In other news, the number of dwelling approvals increased 1.9%M/M in February. Coming after a steep increase in January, this meant that approvals were up 28.4%Y/Y. However, a substantial contributor to that growth has come from surging approvals for cheaper apartments and retirement units – also reflecting demographic trends – as house approvals fell 0.5%M/M in February with annual growth sitting at a much more restrained 9.0%Y/Y. As a result, the value of approvals for residential building, including alterations, increased 14.5%Y/Y – still a solid result, nonetheless. Meanwhile, the value of approvals for non-residential buildings increased an almost equally solid 13.3%Y/Y.

Finally RBNZ Governor Adrian Orr gave a speech today outlining the new monetary policy framework which officially begins on Monday. More interestingly, during the Q&A, Orr indicated that he was happy with the market reaction to RBNZ’s commentary at this week’s OCR review, with particular reference to the weakening of the NZ dollar. But he also encouraged investors to think independently, rather than simply second guess the RBNZ’s stance, so that both financial markets and the RBNZ could learn from each other as new information arrives.

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