BoJ leaves policy setting unchanged

Chris Scicluna

Equities more stable so far after yesterday's torrid showing
Ahead of today’s ECB policy announcements, events yesterday should have eliminated any sense of complacency on the Governing Council. With the new lockdown restrictions bound to whack GDP and further weigh on inflation, a signal of the likelihood of an increase in the PEPP asset purchase envelope by the end of the year, and a readiness to accelerate the pace of purchase before then, would now seem appropriate today.

Certainly, rattled by the resurgence of coronavirus and new restrictions in Germany and later on in France, yesterday was a torrid day for stocks. Europe’s Stoxx50 slumped 3.5% to its lowest level since May, extending its year-to-date loss to over 20%. That loss was later matched by the S&P500, which thus had its worst day since June and reduced its year-to-date gain to just 1%. The VIX closed above 40 for the first time since mid-June and crude oil slumped 5% as market participants contemplated the impact of new restrictions on demand. Although BTPs sold off, greater calm in general was seen in the bond market, where the 10Y US Treasury yield briefly fell below 0.75% but then bounced back a couple of basis points to trade around the levels seen in Asian time. Meanwhile, increased risk aversion drove the Greenback higher against all major currencies aside from yen, with the euro and both the Aussie and Kiwi dollars all declining by a big figure or more.

More happily, however, helped by some positive corporate reporting, US equity futures moved gradually higher over the Asian session, and are presently roughly 1% above where they were when Wall Street closed. So, despite some more alarming vocabulary from Merkel this morning – suggesting that the health services are nearing their limits and that the situation is ‘dramatic’ – European markets are currently little changed. And the declines in Asia-Pacific equity markets earlier were far smaller than what might have been expected, perhaps reflecting these countries superior management of the pandemic.

Indeed, in Japan the Topix pared early losses to fall just 0.1%, notwithstanding a disappointing retail sales report and as the BoJ’s Board met expectations by leaving its policy settings unchanged and revising down its economic forecasts. Investors particularly liked a profit upgrade from Sony, whose stock rallied on upbeat forecasts for sales of the upcoming PlayStation 5 console. In addition, speaking in the Diet, PM Suga said that once current fiscal allocations were spent, he would not hesitate to take further fiscal steps if required (a cut in real estate taxes was mooted by Suga as one possibility). In China, where the CPC’s Central Committee is finishing up its plenary session – perhaps to be followed by a brief communique – the CSI300 once again set its own path, rising 0.75% on what was also a very busy day for local corporate earnings reports.

BoJ policy unchanged; near-term GDP and inflation outlook revised down
As had been widely expected, the BoJ left all dimensions of its policy unchanged when the Board concluded its latest meeting today. So, its short-term policy rate was left at -0.1%, and the 10Y JGB yield target was left at around 0%, with only the usual one dissenter to the decision from among the nine Board members (Kataoka, who continues to call for further easing). In addition, the upper limits for its purchases of ETFs (about ¥12trn), J-REITS (about ¥180bn), corporate bonds (about ¥10.5trn) and CP (¥9.5trn) were all left unchanged too, as was its commitment to purchase an unlimited amount of JGBs as required to hit its 10Y yield target.

With Japan’s economy still perceived to be on a ‘moderate’ improving trend, at this stage there was little sign of any willingness amongst most Board members to take further substantive easing steps over coming months. Nonetheless, as is becoming traditional, the Bank’s forward guidance continues to indicate that short- and long-term policy rates could be lowered at some point if the economic outlook suggests that more stimulus is required. One trigger could be a significant breakout strengthening of the yen. In the meantime, the most likely policy tweak in the near-term is the extension of the ‘Special Program to Support Financing in Response to the Novel Coronavirus’, which is currently scheduled to conclude at the end of March. Indeed, Kuroda flagged that option in his press conference, and agreement to do so could come as soon as the next Policy Board meeting in December.

Given the likelihood of stable policy, attention at this meeting was always going to be principally on the BoJ’s updated economic projections and the associated commentary. The innovations here, compared with the projections made in July and the Board’s last post-meeting statement in September, held no great surprises. The Bank continues to expect a steady pickup in economic activity from now on – albeit with a delayed recovery in the services sector – thanks to the support provided by fiscal and monetary policy. But due to the continued presence of Covid-19 around the world, which is expected to subside only gradually, the pace of recovery is expected to be moderate. And while core inflation is expected in due course to return to positive territory as the base effects from past shifts in global oil prices wear off, weaker inflation expectations mean that inflation is expected to remain well below half of the BoJ’s 2% target through to end-FY22/23.

Perhaps tellingly, the longest paragraph in the section of the statement summarising the Bank’s view was one outlining the extreme uncertainty surrounding the assumptions that underpin the Bank’s outlook and thus the outlook itself. Chief amongst those is the increasingly dubious assumption – at least outside of Japan – that Covid-19 will not spread on such a large scale as to cause the reinstatement of wide-ranging public health measures, a hindrance to financial intermediation and/or a reduction in households’ and firms’ medium-to long term growth expectations. Not surprisingly, the Bank views the balance of risks to both activity and prices as lying to the downside.

Turning to the detail of Board members’ updated forecasts, the median member now expects GDP to contract by 5.5% in FY20, compared to the 4.7% contraction foreseen in July. In our view, that revised forecast remains slightly too optimistic, with a decline of around 6%Y/Y perhaps more likely. Looking further ahead, the median member expects growth of 3.6% in FY21 and 1.6% in FY22 – up 0.3ppt and 0.1ppt respectively compared to the July forecast, but coming off a weaker base. The Core CPI (excluding the impact of the consumption tax and free education policies) is expected to fall by an average of 0.7%Y/Y this fiscal year, before rising 0.4%Y/Y in FY21 and 0.7%Y/Y in FY22. The forecast for this year is 0.1ppts weaker than that forecast previous, while that for FY21 is 0.1ppt stronger – the offsetting differences seemingly reflecting the expected influence of the ‘Go to Travel’ campaign. If anything we would have expected a slightly larger impact given the Bank’s estimate that the campaign will reduced inflation by 0.2ppt this year. The inflation forecast for FY22 was unrevised.

Japanese retail recovery pauses in September, disappointing expectations
Reports from listed retailers had pointed to a further slight lift in consumer spending in September. However, today METI’s retail sales report pointed to a mild but still disappointing 0.1%M/M decline in spending, thus failing to build on an unrevised 4.6%M/M lift in August. With spending having surged last September ahead of the 1 October consumption tax hike, spending was down an exaggerated 8.7%Y/Y compared with the 1.9%Y/Y decline reported in August. In the detail, while there was a lift in spending on food and beverages and general merchandise, together with a fourth consecutive monthly increase in spending on autos and fuel, these gains were offset by weaker spending on apparel and accessories and household appliances – demand for the latter having proven more resilient than other categories with the onset of the pandemic.

Even given today’s disappointing outcome for September, retail spending increased 8.4%Q/Q in Q3, rebounding from a 7.5%Q/Q contraction in Q2. However, it is important to note that the retail sales report can sometimes provide a poor indicator of overall consumer spending. Indeed, this is likely to be especially so at the moment given divergent experience of the retail-dominated goods sector (where spending on durable goods has rebounded strongly) and the services sector (where the recovery has been muted due to weak consumer confidence and a reluctance to spend on travel and hospitality). As a result, it is prudent to await more reliable indicators – such as the BoJ’s Consumption Activity Index on 9 November, due a week ahead of the preliminary Q3 GDP report – before drawing stronger conclusions about how consumer spending fared in Q3.

ECB to signal more stimulus to come as Covid-19 as restrictions take toll?
Yesterday’s announcement of new restrictions by Merkel and Macron, as the two leaders attempted to place a fire-break on the spread of Covid-19, badly rattled the markets. There were similarities between the two approaches, with both sets of measures to last at least a month, and – as in Belgium, the Netherlands and Ireland already this month – restaurants, bars and leisure facilities will have to close. However, reflecting the far greater severity of the situation in France, Macron’s measures were much more stringent, involving the closure of non-essential shops, the sealing of the nation’s borders, and limits on personal liberty (anyone leaving their home will have to carry a special document justifying being out of doors).

With people encouraged to continue working wherever possible, schools still open, and universities to teach online, the hit to French economic output should be much less marked than during the first-wave lockdown, which saw GDP drop a whopping 5.9%Q/Q in Q1 and a further 13.8%Q/Q in Q2. While that lockdown lasted roughly two months – also hopefully twice as long as the current measures – a substantive drop of French GDP in the fourth quarter still now looks inevitable. And while the less stringent measures and vigour in the manufacturing sector might help German GDP avoid such a fate, the likelihood of further restrictions elsewhere means that a double-dip in euro area GDP is now looking very hard to avoid.

Of course, even before the intensification of the second wave, the euro area economy was showing signs of recovery fatigue. And, crucially for the ECB, inflation was already set to remain well below target over the horizon. The latest restrictions will represent a significant further setback for the central bank in its attempt to meet its inflation goal. So, when the Governing Council holds its scheduled policy meeting today, there appears a decent case for the ECB to act promptly and provide additional stimulus.

With less than half of the €1.35trn PEPP envelope used so far, however, the Governing Council will likely see no need to increase the asset purchase target today, while the appetite for rate cuts is also likely to be minimal. It might also want to wait for updated projections in December to enable it to calibrate precisely its policy response. But with market volatility having increased significantly – and euro area stocks down to their lowest levels since the spring – it would seem remiss today not at least to provide a signal that extra stimulus is likely to come at the next meeting. In her press conference Lagarde could also note the ECB’s readiness to accelerate its pace of PEPP purchases before the December meeting from the current rate close to €15bn per week. And she could add that the Governing Council stands ready to act in between meetings should that become necessary too.

Spanish inflation drops to a new four-year low ahead of German figures
Datawise, ahead of the figures tomorrow from the euro area, France and Italy, this morning has brought the first of the week’s flash October inflation releases, from Spain. And these figures disappointed, with Spanish inflation on the EU measure dropping a steeper-than-expected 0.4ppt to a four-year low of -1.0%Y/Y. The limited detail published by the statistical institute suggested that the drop was caused principally by weaker prices of electricity and phone services. The equivalent German figure, due later today, is expected to remain unchanged at September’s five-year low of -0.4%Y/Y. German labour market figures for October are also due this morning. At the euro area level, the Commission’s business confidence indices, also due later on, seem bound to add to evidence of a deterioration in conditions in the services sector over the past month. Finally, ahead of tomorrow’s first estimates of Q3 GDP growth from the euro area and the largest member states, today’s figures from Belgium and Latvia will give an indication of what to expect.

UK car production maintains terrible run with drop to 25-year low
UK car production maintained its terrible performance in September, with output dropping 5.0%Y/Y to 114.7k units, the lowest level for 25 years. Perhaps as a taster for things to come under Brexit, production for exports, which account for more than three quarters of output, dropped 9.7%Y/Y to more than offset the 14.5%Y/Y increase in production for the domestic market. However, so far in the year to-date, total production is down 35.9%YTD/Y, with production for the home market down 38.7%YTD/Y and production for export down 35.2%YTD/Y.

The BoE’s bank lending figures for September are due shortly. These are likely to show that UK demand for consumer credit remained weak last month. In contrast, mortgage lending is likely to have remained relatively robust, with mortgage approvals close to multi-year highs as the clearing of lockdown-related backlogs and the temporary Stamp Duty holiday boosted demand.

GDP report the focus in the US today; jobless claims also worth watching
The key focus in the US today will be on the preliminary national accounts for Q3. A very robust recovery in consumer spending, supplemented by solid gains in residential and business capex, means that the economy likely grew around 30%Q/Q during the quarter. Unfortunately, coming off the low base provided by last quarter’s 31.4%Q/Q slump, this means that the level of GDP will have regained only about 60% of the ground lost this year. The core PCE deflator may rise by the most in three decades due to the reversal of the record discounting that had caused the first ever quarterly decline in overall prices in Q2. Aside from the national accounts, today’s release of the weekly jobless claims report will also be of interest to see whether there are any new signs of slippage in the labour market recovery, although last week’s figures did post an improvement after a few weeks of weakness. Meanwhile, the pending home sales report for September is expected to show that the housing market remains the key beneficiary of the monetary and fiscal stimulus deployed to combat the economic impact of the pandemic.

Australian business sentiment improves; trade prices lower on strong $A
Today NAB released the quarterly version of its business confidence survey for Q3, which provides some additional detail on how firms are viewing the economy. In line with the monthly survey, today’s report pointed to a notable improvement in the closely-followed business conditions index to -4 from the record low of -26 in Q2. However, little further improvement is anticipated over the next three months with the forecast index standing at a historically weak reading of -3. Elsewhere in the survey, firms appear to anticipate little change in overall trading conditions over the next three months, although expectations amongst exporters remain negative. Encouragingly, on balance only a small proportion of respondents expect to reduce employment over the next three months, representing a considerable improvement compared with the negativity evident over the previous two quarters. Margins are expected to remain under downward pressure – as they were even ahead of the pandemic – with product prices expected to rise just 0.1%Q/Q over the next three months. So all up, the survey points to an economy that is expected to continue to run with surplus productive capacity and below-target inflation – an outlook that will almost certainly prompt further policy easing at next week’s RBA Board meeting.

In other news, Australia’s export and import prices moved lower in Q3, not least due to the strong appreciation of the Aussie dollar. Export prices fell 5.1%Q/Q, extending the annual decline to 9.9%Y/Y. Aside from the impact of the exchange rate, key downside influences were lower prices for natural gas – due to contracts that are linked with a lag to developments in oil prices – and continued weakness in prices for coal due to softening demand. Higher prices for iron ore, gold and petroleum provided a partial offset. Import prices fell 3.5%Q/Q in Q3 and so were down 5.7%Y/Y. The main downward contributors were to prices for telecommunications equipment, office machines and apparel, all influenced to varying degrees by discounting and the stronger exchange rate. Price rises for petroleum and some other raw materials provided only a partial offset.

Kiwi business activity outlook confirmed to have improved in October
The final results of the ANZ Business Outlook Survey for October pointed to a slightly larger lift in the key business indicators than first reported, with the later responses more fully factoring New Zealand’s elimination of coronavirus in the community for a second time this year. Most importantly, the own activity index – measuring respondents’ outlook for their own business – improved 10pts to an 8-month high of 4.7 (not dissimilar to the average level over the past three years). And the employment index rose similarly to -2.5, thus also reaching an 8-month high. While the results are encouraging, this seems unlikely to deter the RBNZ from easing policy further next month, especially with the global economic outlook looking sketchier by the day. 

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