Japanese inflation picked up, but activity remained weak

Chris Scicluna
Emily Nicol

Trade-war noise and some disappointing data (including a particularly weak German ifo survey) saw European and US stocks have a torrid time yesterday (the S&P500 closed down 1.2%) while major government bonds rallied (yields on 10Y USTs briefly slipped below 2.30% and those on Bunds fell to -0.12%). But today’s market mood in Asia was more measured. Perhaps given a little support from comments from Donald Trump that a trade deal with China is still a “good possibility” and that Huawei might be addressed in any new agreement, Chinese stocks edged higher (CSI300 closing up 0.25%) while CNY was again little changed. But after the yen appreciated later yesterday to 109.5/$ for the first time in a week, the TOPIX closed effectively unchanged today as the latest Japanese inflation data picked up in line with expectations. But JGBs followed yesterday’s moves in other major bond markets with a modest flattening of the curve (taking 10Y yields down to -0.08%).

European equities have picked up on the better tone from Asia, rising upon the opening this morning. Euro govvies are mixed, with Bunds little changed but BTPs stronger as reports suggest that Salvini’s far-right League has downgraded expectations for the weekend’s European Parliament elections. And in the FX markets, sterling is stronger (back to above $1.265 having approached $1.260 yesterday afternoon) ahead of the expected announcement later today of Theresa May’s timetable for departure from Downing Street. UK retail sales and US durable goods orders are the days most notable new economic data due.

As expected, Japanese inflation picked up in April. Consumer prices rose for the first time in three months, up 0.1%M/M on a seasonally-adjusted basis. But due to base effects, that was sufficient to take the annual headline inflation rate up 0.4ppt to a six-month high of 0.9%Y/Y. And while the core CPI (excluding fresh food prices) measure used in the BoJ’s forecasts also rose just 0.1%M/M on the same basis, its annual rate rose 0.1ppt, also to 0.9%Y/Y, the highest since November. Stripping out energy too, prices again rose 0.1%M/M, helping the BoJ’s preferred core inflation measure rise 0.2ppt to 0.6%Y/Y, the highest since June 2016.

That increase in inflation across the board might look like good news for the BoJ. But, under the bonnet, little seems to have changed. Indeed, much of the upward pressure appears to have come from a temporary boost to prices of package tours and hotels as Japan enjoyed its extended Golden Week holiday from the end of April. In particular, prices of package tours rose more than 15%Y/Y in April, while hotel charges were almost 4% higher than a year ago. As such, recreational services inflation added 0.14ppt to the headline CPI rate. 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.

While the extended Golden Week holiday might well keep inflation elevated in May, we expect this impact to reverse in due course. And while energy prices continue to rise compared with a year earlier (up 4½%Y/Y to add 0.4ppt to CPI), they are likely to provide less support to headline CPI over coming quarters due to base effects. Meanwhile, the introduction of free early childhood education from October will neutralise much of the upwards pressure on CPI from the consumption tax hike. And comments by Chief Cabinet Secretary Suga in the past week reiterated his claim that government action could see mobile charges cut by more than 40% - an outcome that could knock roughly 1ppt off CPI. Overall, therefore, we think that today’s figures will mark the peak in both headline and core measures of CPI, with a steady decline in the BoJ’s forecast core CPI measure to below ½%Y/Y anticipated through to the scheduled consumption tax hike in October, and a good chance of additional underlying weakness thereafter.

While the first estimate of Q1 GDP signalled an acceleration in Japan’s economic output at the start of the year, today’s monthly all industry activity release painted a much more downbeat picture of economic momentum at the end of the first quarter. Certainly, overall output was weaker than expected in March, declining for the second successive month and by 0.4%M/M, to leave it also 0.4% lower than a year earlier. And in the absence of another increase in private sector construction – up 2.2%M/M, the firmest pace since April 2017 – the drop in March would have been much steeper. Private residential construction rose 1.0%M/M while private civil engineering activity leapt 7.8%M/M. In contrast, public sector construction work fell for the first month in three (-1.8%M/M), while tertiary activity was down 0.4%M/M and IP dropped 0.6%M/M.

Over the first quarter as a whole, it was only the construction sector that provided a modest boost to output growth (up 1.9%Q/Q). And with services (0.0%Q/Q) having provided no support, while manufacturing (-2.5%Q/Q) weighed on growth, all industry activity contracted by 0.4%Q/Q in Q1 – a marked contrast to the 0.5%Q/Q expansion implied by the GDP figures. So, while there are often discrepancies between the two sets of data, today’s all industry release suggested a significant possibility of a downward revision to the second estimate of Q1 GDP when it is released on 10 June.

Attention will remain first and foremost today on any announcements about her future from Theresa May, who this morning will discuss the timetable for her departure from Downing Street with the Conservative Party’s 1922 Executive Chair Sir Graham Brady. Reports suggest she will confirm that the official Conservative Party leadership race, which could take several weeks to conclude, will get underway on 10 June, in order for a new leader to be in place before Parliament’s summer recess later in July.

So, that she can try to pass the odd piece of legislation and host the visit to the UK of Donald Trump in the first week of June, May will remain Prime Minister until the Conservative leadership process has been concluded. But her Brexit policy will not see the light of day again. Currently, Boris Johnson is by some margin favourite to succeed her. But given his numerous obvious flaws, an alternative (such as Michael Gove) can’t be ruled out. And whoever the Conservatives choose as their leader will find it no easier than Theresa May to manage Brexit.

Data-wise, the UK’s April retail sales figures will today provide some mild distraction from the political noise. After strong growth in March of 1.0%M/M, which capped a vigorous rebound over the first quarter as a whole (1.6%Q/Q), retail sales are expected to have slipped back a touch. However, the timing of the Easter holiday and unseasonably warm weather will have given a boost to certain categories of spending, and the annual growth rate will likely remain strong at more than 4.0%Y/Y. Meanwhile, the CBI’s latest Distributive Trades Survey, also due this morning, will give a guide to the strength of sales in May.

Preliminary durable goods orders figures for April are due from the US. Recent soft data from the manufacturing sector point to the likelihood of a subdued reading for core orders, while Boeing’s troubles will result in a sharp decline in the volatile aircraft category. The Bloomberg consensus is for a drop of 2.0%M/M in total durable goods orders and a decline of 0.3%M/ in non-defence orders ex-aircraft and parts.

Euro area:
The week is set to end on a quiet note for euro area economic data with no top-tier releases due.

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