Regional reassurance for BoJ

Chris Scicluna

Japanese stock markets returned from yesterday’s national holiday in catch-up mode, with the Nikkei closing up 1.9% to reach its highest close since April. A busy day for Japanese economic data brought nothing to seriously upset the mood (see detail below), perhaps most notably with the BoJ’s latest quarterly Regional Economic Report bringing broadly positive assessments from all nine regions (including an upgrade to one) to suggest that this month’s consumption tax hike need not be quite as harmful for economic growth as the previous two such tax rises.

Of course, the full economic impact of Typhoon Hagibis remains unclear, with ongoing local disruption to power supply and transportation. In this context, PM Abe stated the Government’s readiness to draw on reserve funds, and prepare a supplementary budget if necessary, to provide for reconstruction. And Governor Kuroda said the BoJ would also take stock of the effects of the natural disaster and would strive to manage any impact on financial sector functioning, suggesting that – as would be its usual response to such events – a special funds supplying facility for the affected areas might be announced later this month.

Elsewhere in Asia, stock markets saw a mix of smaller gains and declines, with China in the latter camp (CSI300 closed down 0.4%) as economic data reported a deepening of producer price deflation but increased consumer price inflation in September. But S&P500 index futures have risen. And European stocks have opened higher while sterling has reversed yesterday’s loss, as reports suggest the Brexit negotiations are progressing in a positive direction even if this week’s EU Summit might well come too soon to reach agreement on a deal. (A further Summit in the final week October might be penciled in to seal an agreement, which would then need to be approved by the House of Commons, whose eventual consent cannot be taken for granted.)

In the bond markets, meanwhile, the cash UST market reopened from yesterday’s holidays with yields moving lower across the curve (e.g. 10Y yields are down about 3bps to just below 1.70%). ACGBs followed USTs higher (e.g. 10Y yields down 3bps to 1.01%) even as the latest RBA meeting minutes suggested that another rate cut is less likely to come this year than next. But JGBs followed yesterday’s moves in futures to be weaker across the board (10Y yields up about 1½ bps to about -0.175%). And while most euro govvies followed USTs higher, Gilts are little changed reflecting the aforementioned improved prospects for a Brexit deal at some point over coming weeks.

A busy day for Japanese economic data brought somewhat mixed results, but nothing that would have come as a nasty surprise for the BoJ and shocked it into a rate cut at the Policy Board meeting later this month. Certainly, the BoJ’s own quarterly Regional Economic Report (its version of the Fed Beige Book) suggested that there’s nothing to be overly concerned about. All nine regions reported that their economy had been either expanding or recovering, with the assessments of eight unchanged from the previous quarter and Hokkaido revising up its assessment to say that ‘the economy has been expanding moderately’.

Overall, the conclusion for the BoJ was a familiar one: domestic demand was judged to have continued on an uptrend, with its long-mooted ‘virtuous cycle’ operating from income to spending operating in the corporate and household sectors. At the same time, it predictably restated that exports, production, and business sentiment had been affected by the slowdown overseas. The consumption tax hike was emphasised as a key issue in just two regions (Kinki and Kyushu-Okinawa). 

Meanwhile, the positive impact of the consumption tax on demand in Q3 ahead of the hike was illustrated in the latest tertiary activity figures. These reported an increase in output in the sector in August of 0.4%M/M, the most in four months, following a rise of 0.1%M/M the previous month. All of the gain in August could be explained by the surge in retail activity, up 4.0%M/M, the most since the month before the last consumption tax hike in 2014. A surge in output of utilities (6.5%M/M) and stronger real estate activity (1.3%) was neutralized by declines in wholesale trade (-1.3%M/M) and business services (-1.6%). Growth in August left the average level of tertiary activity in the first two months of Q3 up just 0.2% on the Q2 average. But we would strongly expect a further boost to retail activity in September to contribute to a growth in the sector of ½%Q/Q or more in Q3.

In contrast, however, industrial production is on track for contraction in Q3. Today’s final data for August confirmed the initial estimate that output in the sector declined 1.2%M/M (a larger drop than had originally been expected), largely reversing the increase in July to leave the level of output down a sizeable 4.7%Y/Y, the steepest annual drop since May 2015. The sectoral detail of the report was somewhat mixed, with production of electrical machinery down 4½%M/M, output of production machinery down more than 2½%M/M, and production of cars down ½%M/M. In contrast, output of electronic parts and devices was up 4½%M/M, while ICT equipment production rose 10½%M/M (albeit this series is particularly volatile). Overall, the drop in August left the level of production on average in the first two months of Q3 almost 1% lower than the average in Q2. And the detail of the report suggested the near-term outlook remains weak too with the inventory-shipment ratio up to its highest in more than a decade.

As expected, slowing economic growth and falling commodity prices saw producer price deflation intensify in September, with prices at the factory gate dropping 1.2%Y/Y, the most since July 2016. Within the detail, prices of raw materials fell 4.8%Y/Y (down 1.3ppt on the month) while prices of manufactured items fell 1.2%Y/Y. Producer food price inflation accelerated 0.7ppt to 3.3%Y/Y, contributing to a rise of 0.4ppt in producer prices of consumer goods to 1.1%Y/Y. But producer prices of consumer durables fell 1.8%Y/Y. In terms of the CPI, meanwhile, food inflation rose a further 1.2ppts to 11.2%Y/Y (with pork prices up more than 69%Y/Y). So, while services inflation dropped 0.3ppt to 1.3%Y/Y, the lowest in more than 4½ years, non-food inflation eased 0.1ppt to 1.0%Y/Y, the lowest since March 2016, and core inflation (ex food and energy) remained stable at 1.5%Y/Y, the headline CPI rate rose 0.2ppt to 3.0%Y/Y, the highest since October 2013. And base effects are likely to keep the headline rate above 3.0%Y/Y through to the Lunar New Year.

The noises surrounding the Brexit negotiations have become cautiously optimistic. Yesterday, Antti Rinne, PM of Finland, which currently holds the EU Presidency, doubted scope for a deal at this week’s EU Summit, stating that the technical work needed “more time”. But the EU’s chief negotiator Michel Barnier this morning stated that a deal this week is “still possible” even if it has become “more and more difficult”. We would now expect the Summit on Thursday and Friday to come up with warm words, and look to pencil in a further Summit near the end of the month to try to reach a deal. How that deal would eventually fare in the House of Commons, however, would remain to be seen. While there is likely to be a majority in favour of the deal, the devil will be in the detail of the draft Withdrawal Agreement. And the majority might only back it if it was subject to a confirmatory referendum.

Meanwhile, a busy week for UK economic data gets underway today with the latest labour market report. While employment is likely to have slowed to its weakest rate in a year in the three months to August, the unemployment rate is expected to remain unchanged at 3.8%. Average labour earnings growth seems likely to remain elevated close to the more than decade high of 4.0%3M/Y reached in July. Meanwhile, BoE Governor Carney will testify to Parliament on the Bank’s latest Financial Stability Report while MPC external member will speak publicly on monetary policy.

In the bond markets, the DMO will sell 10Y Gilts.

Euro area:
The ZEW investor analyst survey for October, due later this morning, seems likely to show a further deterioration in perceptions of the German economic outlook. Meanwhile, ahead of the release on Wednesday of the equivalent euro area figures, the final estimates of French inflation in September predictably aligned with the flash data, which saw the EU-harmonised measure of inflation drop 0.2ppt to 1.1%Y/Y. The detail on the national measure confirmed that the decline was led by food and energy inflation. In contrast, services inflation edged higher and the pace of decline in manufactured items slowed. So, core inflation on the national measure rose 0.2ppt to 0.9%Y/Y.

In the bond markets, Germany will sell 2Y Schatz.

In the US, the Empire manufacturing survey results for October represent the only economic data certain to be released on Tuesday although the federal government’s monthly budget statement for September might also be released. FOMC members Bullard and Daly are speaking public on matters that could touch on Fed policy. Meanwhile, the NY Fed will start its T-bill purchases, at a monthly rate of $60bn, under the new programme announced at the end of last week.


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