UK inflation surprises significantly on the downside

Chris Scicluna

US Treasury yields decline as Powell plays down inflation risks and pandemic worries resurface
The 10Y UST yield tumbled for a second day yesterday, falling 8bps to a one-week low of 1.62%, with further downwards pressure evident this morning too. While the moves were principally driven by concerns about the recent pick-up in European coronavirus cases and the latest extension of restrictions in Germany (which were hardly draconian or unforeseen), it was reinforced by Fed Chair Powell’s sanguine comments on the outlook for inflation to the House Financial Services Committee, with Powell indicating that he expected neither a large nor sustained lift in inflation in light of President Biden’s American Rescue Plan. The decline in Treasury yields provided only modest comfort to equity investors yesterday, with the S&P500 still falling 0.8% and the Nasdaq closing with a 1.1% loss. Commodity markets were also notably weaker, with crude oil futures slumping more than $3/bbl to the lowest level in more than five weeks. Meanwhile, risk aversion helped drive a rally in the greenback against most currencies, with the usual exception of the yen.

Against that background, it has been a generally soft day for Asian markets but especially so in Japan and China. A short time ago the TOPIX closed down 2.2%, with energy stocks down 2.8% and financial stocks falling 3.3% amidst a further flattening of the JGB curve (the 10Y yield falling below 0.07% today for the first time in five weeks). In mainland China the CSI300 fell 1.6% to register a new low for this year, while the Hang Seng fell 2.2% as authorities announced a temporary suspension of the BioNTech vaccine due to a packaging defect.

In Australia, the ASX200 bucked the trend with a 0.5% gain despite a drag from energy-related stocks, as both the Aussie dollar and ACGB yields moved lower and the flash PMIs for March cast the economy in a positive light. In New Zealand, where the market had previously swung from pricing rate cuts to rate hikes, the 10Y bond yield fell an especially sharp 16bps to 1.51% as the RBNZ’s QE operation fell short of offers. Investors were evidently keen to hold their bonds in light of the previous day’s announcement of new measures to slow rampant house price inflation (essentially a capital gains tax on investor housing and the phasing out of mortgage interest as a tax-deductible expense for investors).

Japan’s composite PMI lifts marginally in March amid bottlenecks and price pressures; services producer price inflation beat expectations in February
Today’s Japanese flash PMIs pointed to only a modest improvement in business conditions in March, with the headline composite PMI rising just 0.1pts to 48.3, albeit still the best reading since December.

The headline manufacturing increased 0.6pts to 52.0, marking the highest reading since December 2018. However, the output index fell 0.4pts to 52.0. And while the new orders index increased 0.1pt to 52.2 – the highest reading since October 2018 – the new export orders index fell 0.6pts to 50.9 and the employment index fell 0.4pts to 49.7. So rather than being driven by increased activity, this month’s improvement in the headline index was driven by an increase in supplier delivery times – the relevant index, which impacts the PMI inversely, slumping 4.4pts to 42.5 – due to pandemic-driven bottlenecks, rather than especially robust demand. The same bottlenecks, combined with a rising commodity prices and a weaker yen, probably explain a sharp lift in the input prices index, which jumped 4.5pts to 26-month high of 60.1. The output prices index increased a more restrained 0.7pts to 51.8, which was nonetheless the highest reading since April 2019 and now about 3pts above the long-term average.

Turning to the services sector, with local restrictions beginning to be removed during the month, the headline services PMI – the business activity index – inched up 0.2pts to 46.3 but the more forward-looking new orders index rebounded a welcome 2.3pts to a 5-month high of 47.1. A little surprisingly, the business expectations index fell 0.9pts to 56.0 even as the employment index increased an encouraging 1.9pts to an almost 2-year high of 52.5. As in the manufacturing sector, pricing pressures appear to have picked up over the past month, with the input prices index jumping 4.7pts to a 14-month high of 54.8 and the output prices index increasing 0.7pts to a 13-month high of 49.4.

The only other economic release of any note in Japan today was the BoJ’s services PPI report for February, which proved not to be as weak as analysts had expected. In headline terms the index increased 0.2%M/M, which given base effects caused the annual rate of deflation to decline to just 0.1%Y/Y from 0.4%Y/Y in January. A significant contributor to the rebound in inflation came from a lift in prices for advertising services, which had fallen sharply in January in reaction to the restrictions on activity that were imposed during that month. An easing of downward price pressures in the transportation and real estate services sectors was also evident in February, but evidence of the emergence of positive inflation remained hard to come by.

UK inflation surprises on the downside as clothes prices respond to lockdown
Having inched up at the start of the year, UK CPI inflation took a significant step back down in February, declining 0.3ppt to a three-month low of 0.4%Y/Y, below the average of the prior six months. And core inflation fell even further, down 0.5ppt to 0.9%Y/Y, similarly the lowest since November. As has frequently been the case throughout the pandemic, the key driver of the volatility was prices of clothing and footwear, for which the respective inflation rate fell more than 2ppts to a sharply negative -5.7%Y/Y, as retailers faced up to the ongoing impact of lockdown on demand. Second-hand cars, games and toys, recreational and transport services and hospitality also provided downwards pressure. In contrast, higher oil prices saw the pace of decline in petrol prices ease 4.6ppts to -3.5%Y/Y to provide a positive impulse to headline inflation. We should expect fuel prices to further boost inflation over coming months, while the clothing component also seems highly likely to rebound in March, when headline inflation could well rebound back above 1.0%Y/Y for the first time since July.

Euro area and UK March flash PMIs due imminently, with services indices to remain impacted by news on lockdown restrictions
The preliminary euro area and UK PMIs for March are due shortly. In the euro area we suspect these will show little change from February. The headline euro area manufacturing index is likely to move broadly sideways in March from the three-year high of 57.9 last month, with strong growth in the sector likely to be reported in Germany in particular. In contrast, the euro area services PMI seems bound to remain below the key 50 expansion/contraction threshold having been little changed at 45.7 in February, with risks of a deterioration due to the recent extension of restrictions in Germany, France and Italy. In the UK, however, the reopening of schools and hopes for further easing of restrictions ahead means that the flash PMIs should be slightly improved, with the services and composite PMIs likely to rise back above the key 50 threshold from 49.5 and 49.6 respectively in February. Separately, the European Commission’s preliminary estimate of euro area consumer confidence for March, also due to be published later today, is expected to remain close to February’s reading of -14.8, suggesting continued unease about the economic outlook.

Durable goods orders the main focus in the US today; Powell to speak again
Already this week the latest home sales figures have affirmed last week’s pattern of weather-driven weakness in activity during the month of February. Today, Daiwa America Chief Economist Mike Moran expects that poor weather will likely be shown to have also weighed on orders for durable goods, with a decline of around 1%M/M anticipated despite the brisk underlying recovery underway in the manufacturing sector. As usual, the flash Markit PMIs for March will probably attract comparatively little interest, with investors preferring to focus on the ISM indicators that will be released early next month. Meanwhile, Fed Chair Powell will deliver the second leg of his quarterly CARES Act testimony alongside Treasury Secretary Yellen, this time before the Senate Banking Committee.

Australia composite PMI picks up in March as services sector rebounds; preliminary merchandise trade data points to narrower surplus in February
Australia’s flash Markit PMIs – which, like in the US, tend to be largely ignored in favour of more established surveys, pointed to a rebound in growth momentum in March, especially in the services sector. Nevertheless, the composite PMI output index increased 2.5pts to a 3-month high of 56.2 – well above the average recorded since this indicator began in 2016, even excluding the impact of the extreme lows recorded during the pandemic.

The headline manufacturing PMI edged up 0.1pts to a very robust 57.0, with the new orders index rising 0.7pts to 55.8 and the new export orders index rising 0.4pts to a 6-month high of 49.9. Meanwhile, the headline services PMI increased 2.8pts to a 3-month high of 56.2. While the employment index fell 2.3pts from its prior record high to 52.5, the new orders increased 2.6pts to an 8-month high of 56.4 and the new export orders index increased 2.2pts to 14-month high of 48.2. On the pricing front, the composite output prices index was virtually unchanged at 53.5 in March – a relatively robust reading but one that probably won’t provide a great deal of reassurance for the RBA considering that underlying CPI inflation has been below the target band since the before the inception of this index.

In other Aussie news, the ABS released preliminary merchandise trade figures for February. Exports increased 2%M/M in unadjusted terms during the month, lifting annual growth to 16.6%Y/Y from 11.2%Y/Y previously. The monthly growth was accounted for by an increase in rural sector exports, especially meat, although both rural and non-rural goods increased 11%Y/Y. Exports of non-monetary gold, which are very volatile, increased 157%Y/Y in February. However, all of the annual growth in merchandise exports can be singularly explained by a 60%Y/Y lift in shipments of ore, in large part due to surging prices.

Imports also increased 2%M/M in February but thanks to base effects – last February was exceptionally weak – annual growth picked up to 12%Y/Y compared with a near 7%Y/Y decline in January. Imports of consumption goods increased around 4%M/M and 21%Y/Y, led by rebound in imports of road vehicles, while imports of capital goods increased 1%M/M and 19%Y/Y. The preliminary figures indicate an unadjusted merchandise trade surplus of A$8.1bn in February – just A$0.1bn smaller than last month but A$2.0bn larger than a year earlier. However, allowing for seasonality and likely developments in services trade, this suggests that the full trade report will indicate a seasonally-adjusted surplus of a little over A$6bn, down from the record A$10.1bn surplus recorded in January.

Kiwi merchandise trade balance increases in February
New Zealand’s merchandise trade balance moved back into surplus in February, with a small excess of $NZ181m comparing with the $NZ626m shortfall reported during the previous month. About half of that improvement was seasonal, with the remainder accounted for by a seasonally-adjusted 1.1%M/M lift in exports and a 7.5%M/M slide in imports. Even with the gain in February, exports were down 8.5%Y/Y, in part due to a near 15%Y/Y decline in dairy exports (while spot prices have increased sharply in recent months, this will likely not show up in the trade accounts until later in the year). Imports were down 1.1%Y/Y in February, with the decline more than explained by an exceptionally low figure for crude oil, which is very volatile from month to month. Imports of business plant and machinery increased 2.7%Y/Y while imports of consumer goods increased 5.2%Y/Y and imports of passenger motor vehicles jumped 38%Y/Y.

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