Japan's consumer spending to weigh on Q1 GDP

Chris Scicluna

Asian equity markets mostly under downward pressure as pre-CPI jitters continue
With today’s all-important US CPI report looming large, inflation jitters were again evident in financial markets on Tuesday. The 10Y UST yield closed up 2bps at 1.62% with inflation break-evens setting new highs, while larger increases in yields were seen in the UK and German bond markets as local data impressed. As a result, Wall Street was again under downward pressure. However, unlike Monday, technology stocks came away largely unscathed – the Nasdaq paring an early 2% loss to close down just 0.1% – whereas weakness in energy, industrials and financials saw the S&P500 fall 0.9% and the DJI lose 1.3%. In FX markets, the greenback was little changed, although it has firmed in Asian trading today with continued risk aversion sending the major US equity futures contracts at one point down around ¾%. The escalating conflict between Israel and Hamas hasn’t helped sentiment.

Turning to the Asia-Pacific markets, after falling heavily yesterday, the TOPIX has fallen a further 1.6% today. However, the decline in Japan was modest compared to that in Taiwan, where the TAIEX has slumped 4.1% – it had been down double that earlier in the session – following yesterday’s near 4% decline, as investors appear to have rushed to take profits from the table. South Korea’s KOSPI declined 1.5%. By contrast, after bucking the trend with a modest gain yesterday, China’s CSI300 is up 0.4% – perhaps comforted by late yesterday’s PBoC report playing down inflation worries – as is Hong Kong’s Hang Seng after yesterday’s steep 2% decline. In Australia, the ASX200 has fallen 0.7% despite the Government announcing a more expansive than expected and business-friendly Budget (more on this below), with higher-than-expected deficits leading the Aussie 10Y bond yield to rise 6bps to 1.77% today.

BoJ Consumption Activity Index confirms consumer spending to weigh on Q1 GDP report
With Japan’s preliminary Q1 GDP report less than a week away, today the BoJ released its Consumption Activity Index for March – second only to the Cabinet Office’s synthetic consumption index as the most reliable indicator of the national accounts based measure of private consumption. The real index increased 1.3%M/M, driven by a 2.9%M/M rebound in spending on services. And so with spending having slumped in March last year as the pandemic began to impact activity, spending increased 2.5%Y/Y compared with a 5.6%Y/Y decline in February – the first time that annual growth has been positive since the consumption tax was raised in October 2019.

The increase in spending in March follows a 0.9%M/M lift in spending in February, just 0.2ppts less than reported previously, while the previously reported 4.0%M/M slump in spending in January has been materially revised to a 2.9%M/M decline. As a result, today’s figures point to a 1.5%Q/Q decline in real spending in Q1 – to be sure, confirming that private consumption will make a strong negative contribution to GDP growth during the quarter, but likely less than had previously seemed likely. Of course, whether that decline proves short-lived will depend on whether Japan is able to regain control of coronavirus infections over coming weeks, allowing it to ease the restrictions on activity that were re-imposed in Tokyo, Osaka and elsewhere last month.

In other Japanese news, the Cabinet Office released its preliminary business indicators for March. The coincident indicator increased 3.2pts to a 13-month high of 93.1, which was more-or-less in line with market expectations. More positively, a 4.3pt lift in the leading index to 103.2 marked the best reading since March 2014. It will be interesting to see whether tomorrow’s Cabinet Office Economy Watcher’s survey for April is as upbeat on the economic outlook as the leading index and recent PMI readings.

UK GDP drops 1.5%Q/Q in Q1 matching expectations, but firm pickup in March points to strong rebound in Q2
Broadly in line with expectations, the preliminary estimate of UK GDP in Q1 reported a contraction of 1.5%Q/Q. That more than reversed the growth of 1.3%Q/Q in Q4 to leave the level of output down 6.1%Y/Y and 8.7% below the pre-pandemic level in Q419. However, the trough came at the beginning of the quarter. And monthly growth in February (revised up 0.3ppt to 0.7%M/M) and March (an above-consensus 2.1%M/M) left the level at the end of Q1 down a more moderate 5.9% from the pre-pandemic level. And with all indicators pointing to strong growth from April on as the economy reopens, growth in the current quarter should surpass 3%Q/Q to leave the level of GDP in the current quarter at the highest in five quarters.

Indeed, the drop in GDP in Q1 was due principally to the closure of schools and non-essential stores, which are now open once again, as well as hospitality, which is set to reopen fully from next week. In particular, education output dropped a steep 11.8%Q/Q, with accommodation and food services down 18.2%Q/Q and wholesale and retail activity down 5.9%Q/Q. While healthcare provided support (up 1.8%Q/Q), the pandemic restrictions meant that services output fell 2.0%Q/Q to be 8.7% below the pre-Covid peak. In contrast, the drop in manufacturing output was relatively modest (0.7%Q/Q to be 3.4% below the pre-pandemic level), with the decline caused largely by the transport equipment sector (down 1.1%Q/Q). And construction output rose 2.6%Q/Q, albeit remaining 3.4% below the pre-pandemic level.

On the expenditure side, with diminished opportunities to spend, household consumption fell for the second successive quarter, down 3.9%Q/Q to be a steep 12.8% below the pre-pandemic level. Business investment fell 11.9%Q/Q to be down 18.4% from the Q419 level. But public sector activity meant that total fixed investment fell a smaller 2.3%Q/Q. And test-and-trace and vaccinations meant that government consumption rose 2.6%Q/Q. With imports (down 13.9%Q/Q) falling faster than exports (down 7.5%Q/Q), net trade added 2.2ppts to GDP growth in Q1. But following the precautionary stock accumulation ahead of the end of the Brexit transition, inventories subtracted 1.4ppts from growth last quarter.

Euro area IP data to show modest growth at end-Q1; French inflation revised down slightly
Today brings the release of euro area industrial production data for March. Following yesterday’s Italian figures, euro area IP is likely to rise about ½%M/M to be up more than 11%Y/Y. But that would still leave it about 0.8% below February 2020’s pre-Covid level. This morning’s final April inflation data from the two largest member states saw the German numbers align with the flash estimates, e.g. with the EU-harmonised measure (HICP) up 0.1ppt to a two-year high of 2.1%Y/Y. However, the French figures were revised down slightly from the flash estimates, e.g. the HICP measure is now estimated at 1.6%Y/Y in April, up 0.2ppt from March but 0.1ppt lower than previously thought.

April CPI report takes centre stage in the US today
Today brings the release of easily the most market-sensitive data this week, in the form of the US CPI report for April. Daiwa America’s Chief Economist Mike Moran expects both the headline and core indexes to have increased 0.2%M/M (the latter forecast 0.1ppts lower than the market consensus). And with these indexes having fallen 0.5%M/M and 0.4%M/M respectively in April last year, this guarantees another sizeable lift in annual inflation with the headline rate likely to exceed 3½%Y/Y and the core rate rising to around 2.2%Y/Y. More importantly, investors will be looking for any signs of that pricing behaviour is evolving in a way that might lead eventually to a more enduring lift in core inflation. Aside from the CPI, today will also bring the release of federal budget data for April while Fed Governor Clarida is scheduled to speak on the US economic outlook.

Australian government reinvests improved fiscal position back into the economy
As expected, the latest Australian Federal Budget – revealed yesterday evening – pointed to much-improved fiscal starting point compared with that forecast in the December mid-year review. Thanks in large part to a more rapid than expected improvement in the labour market and surging commodity prices, the Government now expects a deficit of 7.8% of GDP in the current fiscal year, down from 9.9% of GDP previously. However, looking ahead, the Government has chosen to reinvest almost all of that improvement back into the economy with a raft of new and extended policy measures, probably not least with one eye on next year’s scheduled General Election. Increased spending on items such as aged-care, support for industries harshly impacted by the pandemic and tax relief for low- and middle-income earners was expected. However, to support SMEs, the Government also announced the (expensive) extension of temporary full expensing of investment and temporary loss carry-back for an additional year. Meanwhile, the Government also announced significantly increased investment in roads and railway projects.

As a result, while the deficit is forecast to decline further to 5.0% of GDP and 4.6% of GDP in the following two fiscal years, this represents no net improvement on the 5.3% of GDP and 4.0% of GDP deficits forecast in December. Thereafter, the deficit is forecast to decline to reach 2.4% of GDP in 2024/25, which is also unchanged from the December forecast update. However, it is worth noting that these forecasts are founded on an assumption of iron ore at $55/t fob – just a quarter of the price that has been attained in recent weeks. It goes without saying that if iron ore remains anywhere near current prices for an extended period, the corporate tax take will be much higher than forecast currently and the Government will have the opportunity to present some combination of lower deficits and/or new policy initiatives at next year’s (likely pre-election) Budget. But for now, Standard and Poor’s reacted to the Budget by leaving Australia’s AAA rating on negative outlook, citing a substantial deterioration of the fiscal headroom required to maintain that rating level.

Given the deficit profile, net debt is expected to increase from 30% of GDP in the current fiscal year to a peak of just under 41% of GDP in 2024/25, just 3ppts less than forecast previously. As a result, the face value of AGS on issue is still expected to rise from an estimated $A963bn at the end of the current fiscal year to $A1,199bn at the end of 2024/25. For the current year, today the AOFM announced that the issuance programme for Treasury Bonds has been revised down by $A20bn to $A210bn, with $A198bn of that programme already completed. With regard to the coming fiscal year, the AOFM said that it would issue $A130bn of Treasury Bonds and $A2.25bn of Treasury Indexed Bonds, with more detail to be announced on those programmes on 2 July. While that programme is larger than expected, it still implies fewer bonds entering the market each month than the RBA is currently buying, which may well at least cause the RBA to slow its purchase rate when it reviews its QE programme at the July Board meeting.

Finally, one point of note in the accompanying economic forecasts is that the Treasury appears to have a higher estimate of the NAIRU than the RBA, with CPI inflation forecast to return to 2½% in 2023/24 even with the unemployment rate no lower than 4½%. By contrast, the RBA appears to anticipate that the unemployment rate will need to decline below 4% in orders to generate a material lift in wage and CPI inflation.

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