Success at the EU Summit

Chris Scicluna
Emily Nicol

After yesterday’s gains on Wall Street, which saw the NASDAQ rally 2.5% to be up 20% in the year to date, the news a few hours ago of a deal in Brussels on the EU’s recovery plan gave a further boost to risk appetite. So, Asian stocks advanced further (the Topix and CSI300 rose less than 0.5%, but the Hang Seng is up more than 2%) while euro area equities are up more than 1% at the open, and the DAX has now all but reversed its loss from the start of the year.

In bond markets, BTPs are outperforming again, with the 10Y spread over Bunds now down about 5bps to close to 150bps, the lowest since February. But while futures point to further stock gains on Wall Street, yields on USTs are again steady. And JGBs made gains, particularly at the long end, after the 20Y auction met with solid demand and Japan’s latest inflation data broadly aligned with expectations, although core inflation (exc. fresh food) inched back up to zero percent.

EU Summit:
A few hours ago, the EU summit, which kicked off on Friday, finally reached agreement on the recovery package that will see the Commission issue up to €750bn of bonds by the end of 2026. Up to €390bn of the funds raised will be dished out to member states in grants, with the remaining €360bn to be disbursed in the form of loans. The amounts raised on the capital markets will be of various maturities, to be fully repaid by end-2058.

While the total amount of grants is, of course, less than the €500bn originally proposed by Germany, France and the Commission, it is substantive nevertheless, particularly in light of the persistent opposition of the so-called “frugal four” (NL, AUS, SWE, DEN). Indeed, in nominal terms the total amounts issued and disbursed should be higher than stated given that they are expressed in 2018 prices.

Under the main plank of the package – the Recovery and Resilience Facility (RRF), which will total €672.5bn and of which €312.5bn will be disbursed in the form of grants – 70% of the grants will be committed in 2021 and 2022, with the remainder to be committed by end-2023. As a rule, the maximum amount of loans for each member state will be 6.8% of its GNI.

The precise share of funds to be allocated to individual member states is not yet clear. Indeed, it will be linked partly to the eventual magnitude of the declines in GDP this year and next. With Italy, Spain and France on track to be the worst affected member states in terms of the hit to economic output – with declines in GDP in 2020 likely to be more than 10% – they should be among the largest beneficiaries, notwithstanding their net contribution to the overall EU budget. Indeed, Italy expects to benefit from 28% of the funds on offer, estimating that it will perhaps receive more than €80bn in grants and more than €125bn in loans. And Spain expects to get almost 19% of the total amount, including roughly €70bn in grants. As such, bond market investors are content, with BTP yields down a further 3-5bps across the curve, with the 2Y spread over Bunds down to 62bps and the 10Y spread over Bunds down to 151bps, the lowest since February.

Of course, a large share of the issuance by the European Commission will likely be purchases by the ECB under its asset purchase programmes – indeed, the rules of the PSPP allow the Central Bank to hold 50% of any issue by an eligible supranational institution. And those purchases will, among other things, help to relax concerns about the ECB’s holdings of certain national bonds hitting its self-imposed limits too. Moreover, with projects related to climate change among those to benefit, almost one third of the European Commission’s issuance could take the form of green bonds, representing a massive boost to the size of the market.

There were no surprises from today’s Japanese inflation figures, which showed that prices increased for the first month since December (by 0.1%M/M), to leave the annual CPI rate unchanged at 0.1%Y/Y for the third consecutive month. The BoJ’s forecast core CPI rate (excluding fresh foods) edged slightly higher to zero, the first non-negative reading for three months. The internationally comparable core inflation rate (excluding food and energy) also ticked slightly higher to 0.2%Y/Y, while the BoJ’s preferred new core rate (excluding fresh foods and energy) was unchanged at 0.4%Y/Y. Of course, when excluding the impact of the consumption tax hike and government education policies, headline inflation and the BoJ’s forecast core measure remained in deflationary territory, at -0.2%Y/Y and -0.4%Y/Y respectively.

Within the detail, a moderation in fresh food prices (down 2.6ppts to 3.2%Y/Y) largely offset an easing in the pace of decline in gasoline prices (up 4.2ppts to -12.2%Y/Y). But while there was a notable jump in mobile phone charges last month (up 4.9ppts to 1.6%Y/Y), as well as a modest upwards pull from prices of air conditioners, non-energy industrial goods inflation edged slightly lower, to 2.0%Y/Y. And with hotel costs and other recreational services prices still weak due to the pandemic, services inflation remained in negative territory at -0.3%Y/Y.

With wage growth having recently slipped into negative territory, this year’s spring wage round having brought the smallest negotiated increase for seven years, and surveys pointing to a further weakening of labour market conditions, services inflation will likely remain subdued over coming months. Moreover, with energy prices to remain a drag for the time being and weak demand likely to weigh on goods prices too, we expect inflation to remain in negative territory through to early 2021.

The latest department store sales figures certainly illustrated ongoing weakness in domestic demand, even before the renewed spike in coronavirus infections in tokyo. In particular, sales were down 19.1%Y/Y in June, admittedly a notable improvement from the declines seen in May (-66%Y/Y) and April (-73%Y/Y), but nevertheless the ninth consecutive annual drop. Sales of clothing were supported somewhat by clearance sales, while big-ticket items also reportedly fared better than had been expected. But spending on cosmetics remained weak in the continued absence of foreign visitors.

Against the gloomy backdrop of the renewed lockdown in Melbourne and new restrictions on the hospitality sector in New South Wales, the government today extended its JobKeeper scheme by six months to 28 March, but reduced fortnightly payments in Q4, which will be followed by a further reduction in Q1 too. The government expects this to coincide with a fall in the number of those currently receiving the payments from 3.5mn to 1.4mn in Q4 and 1mn in Q1. Of course, given the uncertain economic outlook not least associated with the second wave of coronavirus infections, the outlook for the labour market looks weak. And we might well see the government job support schemes extended further.

Indeed, as noted in a speech by RBA Governor Lowe today, with scope for significant new monetary policy support limited, the more substantive policy initiatives seem likely to be driven by the fiscal side. Of course, he judged the RBA’s current yield curve control framework to be working well and did not see the need to adjust it right now. Nevertheless, he reiterated that the Reserve Bank would continue to review overseas experiences with other options, including lowering the cash target rate to say 10bps, targeting a different yield, and/or adjusting the parameters on the term funding facility. This notwithstanding, he noted that there had been no change to the Board's view that negative interest rates were 'extraordinarily unlikely' in Australia, while also emphasising that monetary financing of fiscal policy was not under consideration either.

European and US data:
A relatively quiet day for economic data today will see Eurostat publish government deficit and debt figures for member states in Q1. In the US, where Treasury Secretary Mnuchin will hold discussions with house Speaker Nancy Pelosi on a new fiscal support package, today’s dataflow will bring just the Chicago Fed survey for June, which is expected to show a further modest improvement in activity ahead of the recent spike in coronavirus cases.

Finally, the UK’s public finance figures released this morning confirmed a drop in the public sector net cash requirement of more than £25bn to £44.0bn, a level surpassed slightly in two months following the global financial crisis as well as in April (when it peaked at £72.3bn) and May this year. The less reliable figure of public sector net borrowing (excluding banks) fell £10bn from May to £35.5bn.

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