Japan’s return to deflation

Emily Nicol
Chris Scicluna

After European and US stocks finished April by a selling off, Japanese stocks did likewise today, with the Topix closing down 2.2% to end the week up just 0.3%. Elsewhere, most other markets in the region were closed for national holidays, although the main Aussie index fared even worse, closing down 5.0%. US and European stock futures are pointing to further losses ahead too.

Ahead of Japan’s Golden Week holidays from Monday to Thursday and a seemingly inevitable extension to the national state of emergency, however, JGBs were little changed. But USTs made modest gains while the curve flattened (10Y yields down about 2½bps to close to 0.61%) against the diminished risk appetite. In forex markets, the dollar stabilised after sliding steadily over the course of the week (DXY is close to 99.0 down from a peak near 100.9 on Monday).

Certainly, after yesterday’s dreadful economic data out of Europe and the US, there was little in the news-flow today to provide cause to cheer today. After Amazon cautioned that it might chalk up a loss in the second quarter, Japan’s manufacturing PMI was even weaker than previously thought while Tokyo core inflation slipped into negative territory for the first time in three years (see detail below). Elsewhere, South Korea’s trade data were even weaker than expected, with exports down 24.3%Y/Y, the steepest decline since the global financial crisis. And with imports down a somewhat more moderate 15.9%Y/Y, the Korean trade balance registered a deficit for the first time in more than eight years.

Looking ahead, while much of Europe is closed for May Day holidays, the ECB will shortly publish its economic scenarios that will help explain Christine Lagarde’s downbeat tone at yesterday’s press conference. And the US ISM manufacturing survey out later on could chalk up some record low readings.

After the BoJ at the start of this week revised down significantly its near-term growth and inflation forecasts – with negative outturns anticipated for both variables in the current fiscal year – today’s advanced Tokyo CPI numbers for April posted a steeper than expected weakening in underlying price pressures. Admittedly, headline inflation came in as expected, nevertheless still declining 0.2ppt to 0.2%Y/Y, the lowest reading since October 2017. And this was despite a positive impulse from fresh food prices, with the annual rate of increase up a steep 5.9ppts to 6.2%Y/Y. Indeed, when excluding such items, the BoJ’s forecast core measure of CPI inflation fell 0.5ppt to -0.1%Y/Y, the first negative reading for three years. The BoJ’s new preferred core inflation (excluding fresh foods and energy) similarly fell 0.5ppt to 0.2%Y/Y. And the internationally comparable measure of core inflation (excluding food and energy) also declined 0.5ppt to -0.2%Y/Y, by far the lowest of the G7 economies. Moreover, when adjusting for the consumption tax hike and government policy measures, this measure stood at an even weaker -0.4%Y/Y. Indeed, on an adjusted basis, headline and all core measures fell to zero or below.

Within the detail, there was an inevitable drag from energy inflation, down 1ppt to -4.3%Y/Y in April, as the annual rate of gasoline prices dropped 8ppts to -8.1%Y/Y, the weakest since October 2016. The government’s extension of free education to High Schools also played a role, with overall school fees down 11.7%Y/Y. But there were also signs that weaker demand was weighing on prices. For example, prices of household durable goods fell notably in April (-4.1%Y/Y) to the weakest since late-2016. And the Covid-19 hit to tourism was clearly evident in a sharp drop in hotel charges, down 6.3ppts to -7.7%Y/Y, the steepest annual decline since the series began in the early 1970s. Looking ahead, a further weakening in demand over the months ahead, the plunge in oil prices and lower mobile phone charges are all likely to drag further on headline and underlying inflation. So, our colleagues in Tokyo currently expect the BoJ’s forecast measure of national core inflation to fall back into negative territory in April and follow a gradual downward trend in the months ahead. Certainly, we wouldn’t be surprised to see core inflation over the year as a whole come in at the lower bound of the BoJ’s latest forecast (-0.7% to -0.3%) or below.

The weakening in domestic demand was unsurprisingly evident in the latest vehicle sales figures last month too. Indeed, total sales were down more than 25%Y/Y in April, the eighth consecutive year-on-year decline and a similar pace of fall to that seen after October’s consumption tax hike, albeit a long way off the near-50%Y/Y drop seen after the 2011-quake. Today’s final manufacturing PMI survey also suggested a marked deterioration in conditions in the sector towards the end of last month. In particular, the headline index was revised down from the flash by 1.8pts to 41.9, a drop of 2.9pts from March and the lowest level for eleven years. There were more marked revisions to the output and new orders components too, to leave the respective indices down 6.4pts on the month to 34.7 and down 4.6pts to 33.3, similarly the weakest since the height of the global financial crisis.

The end of the week will bring the final UK manufacturing PMI for April which is expected to reinforce the message of the preliminary figures that output fell sharply over the past month – indeed, the flash estimates showed the output PMI declining a record 27.2pts to a series low 16.6, with the new orders and business expectations indices similarly pointing to a bleak near-term outlook. The headline PMI will fall to a lesser degree as it is counter-intuitively boosted by a lengthening of supplier delivery times. Today will also bring the BoE lending figures for March. While consumer credit growth will have remained positive, the number of mortgage approvals and associated loans are likely to have fallen significantly as the housing market has effectively come to a standstill. But, as in the euro area, lending to businesses is likely to have jumped as firms faced near-term liquidity constraints.

The Nationwide house price data for April, released this morning, might have raised eyebrows. In particular, the survey’s headline measure of annual house price growth jumped 0.7ppt to 3.7%Y/Y, the strongest such pace for more than three years. The monthly price rise of 0.7%M/M was the seventh successive rise. However, the index is based on mortgage approval data, and Nationwide cautioned that about 80% of the transactions informing the April figure were based on mortgage applications submitted before the UK’s lockdown that kicked in and when momentum in the market was still positive. Indeed, with new activity in the UK housing market effectively having ground to a halt, Nationwide also cautioned that the mere construction of its house price index over coming months could prove problematic. And the outlook for UK house prices is, of course, highly uncertain.

Euro area:
After the ECB yesterday took further steps to support the flow and reduce the cost of credit to liquidity-constrained businesses, the Bank will today publish new scenarios for the economic outlook, which informed Lagarde’s suggestion yesterday that GDP will likely drop between 5-12%Y/Y this year – and perhaps by as much as 15%Q/Q in Q2.

In the US, today will bring the manufacturing ISM and final Markit manufacturing PMI for April. Both are expected to point to a sharp contraction in output in the sector, declining orders and weak employment.

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