German GDP flat, Japan’s services soft

Emily Nicol
Chris Scicluna

After Wall Street struggled for direction yesterday (the S&P500 and NASDAQ both closed down a little less than 0.2%), stock markets in Asia were mixed today, not least as investors struggled to interpret the latest data on the coronavirus following yesterday’s methodological changes. For the record, Hubei province reported an extra 4823 cases, down from the near-15k increase yesterday. But revisions to the number of fatalities – the overall death toll was revised down by more than 100 due to double-counting – reinforced the sense of confusion.

Nevertheless, some reassuring sounds from the WHO, as well as unattributed reports that the PBOC plans to ease up on its property-loan quotas, and the Chinese administration might also use fiscal policy more actively to support growth, helped China’s CSI300 reverse yesterday’s decline to advance 0.7% on the day. The Hang Seng (up 0.3%) and Korean KOSPI (up 0.5%) also rose as have US Stock futures. But in contrast, and despite a stable yen, there was no love for Japanese stocks this St Valentine’s Day (the TOPIX fell 0.6%) in the wake of yesterday’s first confirmed local coronavirus fatality. The latest Japanese services sector data also disappointed, adding to evidence that Monday’s Q4 GDP data will be very weak indeed (see below for more detail).

In the bond markets, USTs made modest gains across the curve in Asian time (10Y yields are down about 1½bps to close to 1.60%) in the wake of yesterday’s announcements from the NY Fed that, for a second successive month, it will shrink its liquidity-supporting repo operations while maintaining its $60bn monthly pace of purchases of T-bills. But JGBs were a touch weaker (10Y yields up 1bp to -0.03%) ahead of next week’s auctions, while the Diet confirmed the latest appointment to the BoJ Policy Board – the seemingly very dovish Seiji Adachi is replacing Yutaka Harada, similarly a fan of the central bank’s current monetary policy framework.

In Europe, meanwhile, euro govvies have made gains this morning (10Y Bund yields edging back closer to -0.40%) while the euro has touched a new 2½-year low against the dollar as data confirmed that Germany’s economy failed to grow last quarter. And 10Y Gilt yields remain up about 5bps from this time yesterday and sterling is also stronger in the wake of yesterday’s political developments, which saw PM Johnson and his chief adviser Dominic Cummings take effective control of the Treasury, suggesting that we might want to brace for a significant relaxation of fiscal discipline ahead (more on all this below too).

Today’s economic data suggested that the services sector – which accounts for roughly 70% of total output in Japan – struggled to regain momentum at the end of 2019 following the hit of October’s consumption tax hike. Contrary to expectations of a second successive monthly rise, tertiary activity fell 0.2%M/M in December to be down 0.8%Y/Y. While the decline at the end of the year was modest compared to the rise of 1.4%M/M in November, the sharp drop in October meant that activity in the sector was still down a hefty 2.8%Q/Q in Q4, coincidentally matching the fall over the quarter following the previous consumption tax rise in 2014.

Retail trade was perhaps inevitably among the weakest performers following the tax hike, down a whopping 7.5%Q/Q in Q4. And wholesale activity was little better (down 6.1%Q/Q). Transport and postal activities (down 3.7%Q/Q) and information and communications (down 2.5%Q/Q) also chalked up steep declines. At the other end of the spectrum, thanks to a strong end to the year, hotels saw an improved performance in Q4 (up 2.7%Q/Q). And business-related services (up 0.8%Q/Q) and medical and healthcare (up 0.2%Q/Q) were relatively immune to the tax hike, similarly avoiding contraction.

With tertiary activity down 2.8%Q/Q, and preliminary data for the industrial production having previously suggested a drop of 4.0%Q/Q, GDP certainly fell markedly in Q4. However, these activity data tend not to align fully with the figures for overall output growth presented in the national accounts. When the first estimate of GDP is published on Monday, our colleagues in Tokyo expect economic output to have contracted by 1.3%Q/Q, a smaller drop than implied by the services and IP figures but a touch steeper than the consensus forecast. Notwithstanding back revisions (which occur frequently and often by a sizeable magnitude), this would leave Japan’s GDP up just 0.3%Y/Y, down from growth of 1.7%Y/Y in Q3 and well below estimates of the potential rate.

Of course, the weakness will principally reflect the hit to household expenditure in the aftermath of October’s consumption tax increase. Indeed, the anticipated contraction in GDP looks set to be more than fully accounted for by private consumption, with our colleagues’ expectation for a decline of 2½%Q/Q which would mark the steepest drop since the 2014 tax hike (albeit at roughly half that pace). Private sector housing investment is also expected to have declined for the first quarter in six, while private capex is expected to knock a further 0.2ppt off quarterly GDP growth. This will, however, be offset by stronger government spending, while net trade looks set to have made a very modest positive contribution too.

Euro area:
Germany’s economy avoided contraction in the fourth quarter of 2019 but only just. GDP in Q4 was unchanged from Q3 to be up just 0.4%Y/Y on a calendar-adjusted basis. And given the decline in Q2, the level of GDP in Q4 was still marginally below that in Q1. Thanks to back revisions, however, full-year growth was revised up by 0.1ppt to 0.6%Y/Y.

No detailed arithmetic for the various expenditure components was published today. However, the German statistical agency stated that household and government consumption slowed markedly in Q4. And investment in machinery and equipment fell sharply. In contrast, investment in construction and other fixed assets reportedly continued to increase. That, however, jars somewhat with last week’s construction data, which reported a drop of 1.9%Q/Q in the sector last quarter. Meanwhile, in volume terms, exports fell slightly while imports picked up to suggest that net trade subtracted from economic growth.

With economic output in Germany flat, France (-0.1%Q/Q) and Italy (-0.3%Q/Q) having contracted, but Spain having accelerated (0.5%Q/Q), today’s updated euro area GDP figures now seem likely to confirm the flash estimate of growth of just 0.1%Q/Q, 1.0%Y/Y. Despite the soft backdrop, however, today’s euro area employment figures will also likely show that job growth stepped up slightly from the 0.1%Q/Q increase of Q3. December’s trade figures will also provide more colour on the performance of exports at the end of 2019 – if the German data are anything to go by, expect them to be weak.

Yesterday’s news that Sajid Javid had resigned as Chancellor of the Exchequer, due to an argument with Boris Johnson over the roles played by his advisers, had an immediate substantive impact on Gilts and sterling. In our view, those market shifts were appropriate. The new organisational arrangements imposed by Johnson, which triggered Javid’s resignation, represent a significant loss of independence for the Treasury, which will effectively now come under the command of the Prime Minister and his chief adviser Dominic Cummings. And Javid’s replacement Rishi Sunak will now be Chancellor in name only, forced to share his own advisers under the control of Number 10 Downing Street.

We should therefore now expect the Government’s commitment to fiscal prudence, and to its currently stated fiscal rules, to be weaker than would otherwise have been the case. And so, the forthcoming Budget announcement – still pencilled in for 11 March – is likely to imply looser fiscal policy than otherwise would have been the case. Indeed, don’t rule out a Trump-style big-bang stimulus. And we should also expect future UK public spending decisions and tax policy changes to be driven more by politics and ideology than economic analysis. That’s likely to be bad news for the UK economy’s medium- to longer-term prospects. But the expectation that fiscal policy will be looser than previously expected also implies that the BoE will be less inclined than it otherwise would have been to cut rates further. We now don’t expect further easing before Q4, if at all this cycle.

In the US, the most notable economic data today will be retail sales figures for January, expected to report a solid increase at the start of the year following a relatively slow holiday shopping season. In contrast, the IP report for the same month seems likely to disappoint, with manufacturing output forecast to have more than fully reversed the increase in December and production cuts at Boeing a notable downside risk. Today will also bring the preliminary University of Michigan consumer sentiment survey for February.

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