UK CPI surprises on the upside

Chris Scicluna
Emily Nicol

Bond yields move higher following another huge upside inflation surprise in the US
Yesterday’s markets were dominated by another significant upside surprise in the US CPI, with both the headline and core indices rising 0.9%M/M in June – about double the consensus expectation – sending core inflation to a near three-decade high of 4.5%Y/Y. While an immediate rise in UST yields was pared temporarily, yields moved higher again following the release of the latest 30Y auction results, leaving the 10Y up 6bps at 1.42% and the 30Y up 5bps at 2.05%. All told, the sell-off can only be described as moderate considering the scale of the forecast miss. Clearly, investors took some comfort knowing that much of the excess inflation can be ascribed to price normalisation associated with the reopening of the economy ongoing supply disruptions flowing from the (especially severe in the transport sector). However, Daiwa America’s Mike Moran notes the CPI also contained hints of underlying price pressure, with owners’ equivalent rent, household furnishings, alcoholic beverages and cable TV services amongst the prices showing a stronger trend in recent months. Wall Street was not too concerned with the CPI outcome, with the S&P500’s 0.35% decline simply reversing the previous day’s rally. Meanwhile, the lift in Treasury yields boosted the greenback, with gains made against all the main counterparts.

Since Wall Street closed US equity futures are a tenth or two weaker and the 10Y UST has rallied 2bps to just below 1.40%. Against that background, most bourses in the Asian region have lost ground today, but losses have generally been small. The market has been weakest in China, where the CSI300 has currently shed 1.1% ahead of tomorrow’s Q2 GDP report and June activity indicators. By contrast, the TOPIX has declined just 0.2%, with the latest Reuters Tankan reporting the best manufacturing conditions since November 2018 (sadly not replicated in the non-manufacturing sector, which continues to be impacted by the pandemic). Stocks were weaker in Hong Kong and South Korea, with investors in the latter now awaiting tomorrow’s BoK policy meeting.

In the Antipodes, the focus today has been on the RBNZ’s latest policy review. While the Bank did not address explicitly the outlook for the Official Cash Rate, today’s key decision to halt its asset purchase programme suddenly – by next Friday no less! – indicates that the possibility of an early hike is being given serious consideration by policymakers. Indeed, emboldened by this decision, the market is now pricing almost a two-thirds chance of a rate hike at the next meeting in August, with three of the big four local banks now forecasting such a move. Unsurprisingly, this has lit a fire under the Kiwi dollar, which has more than erased its overnight losses against the greenback, while the 10Y NZGB increased 7bps to 1.73%.

By contrast, the 10Y AGCB has increased just 2bps to 1.34% today, with news of a small increase in the Westpac consumer confidence index countered by a disappointing increase in new virus cases in Sydney. Unfortunately, the latter has prompted the New South Wales Premier to extend the city’s lockdown by a further two weeks, until at least 30 July. Nonetheless, Australia’s ASX200 underperformed others in the region, closing slightly in the black. In Australia, attention will now turn to tomorrow’s key Labour Force Report, while Friday’s CPI report in New Zealand will command attention on both sides of the Tasman.

Japan’s Reuters Tankan points to further improvement in the manufacturing sector, non-manufacturing conditions slightly weaker as restrictions continue to weigh
Unsurprisingly, today’s Reuters Tankan continued to indicate a sharp dichotomy between the business conditions facing manufacturing and non-manufacturing firms, with that dichotomy widening over the past month. The overall diffusion index (DI) for manufacturers rose 3pts to 25 in July, which is both the best reading since November 2018 and well above the long-term average (which sits around zero). The forecast DI – which measures expected business conditions three months ahead – increased 7pts to 28, indicating that respondents expect business conditions to become even more favourable in the near term. By contrast, in light of ongoing restrictions on activity in the retail and hospitality sector, the overall non-manufacturing DI slipped 3pts to -3 – a three-month low that well below the long-term average (which is around 5). The forecast DI fell 2pts to 8, but this still indicates that firms expect an improvement in business conditions over the next three months (presumably once pandemic restrictions are eased).

At the industry level, in the manufacturing sector, by far the largest improvement this month was in the sheet metal industry, which described business conditions favourably for the first time since December 2018. This was related perhaps to an increase in optimism in the auto sector, where the DI improved 16pts to 46 – the highest reading since November 2007, now exceeding the optimism of all other manufacturing industries. These increases were partially offset by reduced optimism in the chemicals and electrical machinery industries, although both remain very positive (only the textiles industry continued to view conditions as unfavourable). Within the non-manufacturing sector, the DI for retailers lifted 17pts to -5. However, optimism evaporated amongst firms operating in the transport industry and optimism in the information services industry – which has been sky high this year – cooled, with the DI falling 24pts to 36.

Japan’s industrial production falls 6.5%M/M in May – deeper than first estimated
In today’s other Japanese economic news, notwithstanding the positive trend in the manufacturing sector, final IP figures for May showed a deeper pullback in production than indicated by METI’s preliminary report. Total production is now estimated to have decreased 6.5%M/M – 0.6ppts more than estimated previously – with production of non-durable consumer goods now estimated to have declined 5.0%M/M compared with just 1.5%M/M previously. As before, the steepest declines were seen in durable consumer goods (-17.3%M/M) and capital goods (-5.6%M/M), both unrevised from their preliminary readings. Given this revision, output is now set to grow less than 1.0%Q/Q in Q2 even if production rebounds a sturdy 5.4%M/M in June in line with METI’s bias-corrected estimate.

Elsewhere in the report, the decline in shipments was revised to 5.5%M/M – 0.8ppts larger than estimated previously. As a result, inventories fell 1.1%M/M – 0.6ppts less than estimated previously – and so were down 8.7%Y/Y. As always, the brand new content in today’s release concerned capacity utilization, which in aggregate slumped 6.8%M/M in May to a six-month low, having previously sat at the highest level since September 2019 (i.e. just ahead of the consumption tax hike). Firms’ productive capacity fell 0.2%M/M in May and was down 1.2%Y/Y.

UK CPI surprises on the upside to near-3-year high with broad-based drivers, so core inflation comfortably exceeds expectations too; but PPI inflation moves past its peak
Following yesterday’s stronger-than-expected US CPI figures, this morning’s UK inflation release similarly reported another upside surprise in June, with headline CPI jumping 0.4ppt to 2.5%Y/Y, the highest rate since February 2018. While this in part reflected higher energy inflation (up 0.9pppt to 10.3%Y/Y), the increase was broad-based. Inflation of non-energy industrial goods rose 0.5ppt to 2.8%Y/Y, with services inflation up 0.2ppt to 2.1%Y/Y. As such, core inflation also jumped 0.3ppt to 2.3%Y/Y, also the highest since February 2018.

Following yesterday’s US data, it was notable to see higher prices of second-hand cars (up 5.6%Y/Y after a rise of just 0.9%Y/Y in May) as one driver of higher inflation, seemingly reflecting increased demand following the reopening of the economy and reduced demand for public transports, perhaps as well as supply bottlenecks impacting production of new autos (inflation of new cars fell back 0.2ppt to 3.2%Y/Y however). In addition, inflation of clothing and footwear jumped 0.9ppt to 3.0%Y/Y, exaggerated again by the change to seasonal price patterns, a low base this time last year, and decent demand associated with the relaxation of pandemic restrictions. Similarly, the hospitality component maintained its upwards trend, with inflation of hotels and restaurants up 0.7ppt to 2.5%Y/Y, having been just 0.9%Y/Y a year earlier.

In contrast to the CPI, however, today’s producer price inflation figures surprised to the downside in June, suggesting that pipeline pressures might now have peaked. Indeed, input prices of materials and fuels fell 0.1%M/M to leave the year-on-year increase moderating 1.3ppts to 9.1%Y/Y, a three-month low. And while output prices rose 0.4%M/M, that meant that the equivalent annual rate of inflation also eased slightly by 0.1ppt to 4.3%Y/Y.

Looking ahead, the inflation outlook in the UK is highly uncertain. While some of the upwards pressure from certain goods – including clothing and recreational items – might well ease back over coming months as base effects adjust, services inflation might be expected to take a further step up as more restrictions are lifted, staycations place domestic tourism prices under additional pressure and international travel resumes too. Moreover, base effects associated with last year’s hospitality subsidies and VAT cut are likely to see headline inflation take a further step up in August. So, we expect the headline CPI rate to temporarily break above 3%Y/Y later in the year. But with energy inflation set to ease significantly, pandemic-related base effects from other items also gradually to wear off, and stronger sterling also likely to weigh on prices of imported goods, we continue to expect the headline CPI rate to fall back close to and eventually below 2.0%Y/Y in the second half of 2022.

Euro area IP figures for May ahead; final Spanish inflation data for June revised up but core measure still exceptionally weak
Today brings euro area industrial production figures for May. While manufacturing output dropped 0.5%M/M in Germany and France, and a steeper 1.2%M/M in Italy, aggregate euro area production is expected to have moved broadly sideways, supported by a surge in 4.3%M/M in Spanish IP. Meanwhile, unlike yesterday’s equivalent data from Germany and France, the final Spanish inflation figures for June were revised up slightly from the flash estimates so that the EU-harmonised HICP measure is now estimated to have risen 0.1ppt to a four-year high of 2.5%Y/Y. The national measure was unchanged from May at 2.7%Y/Y. But with food and energy the main sources of recent pressure, core Spanish inflation remained exceptionally low at just 0.2%Y/Y.

PPI the initial focus in the US today, followed by Powell testimony; Fed Beige Book also due, while more earnings reports ahead from the banking sector
Following yesterday’s further massive upside surprise in the May CPI report, the initial focus in the US today will be on the PPI for June. Daiwa America’s Mike Moran expects a solid 0.5%M/M lift in the headline index, leaving annual inflation close to last month’s 6.6%Y/Y pace. With the economy continuing to reopen, he expects further price normalization and robust demand to drive a 0.4%M/M lift in the core index, which should raise annual inflation to around 5.0%Y/Y. Needless to say, the market is likely to wary of a further upside surprise in this report too. Whatever the outcome, just a few hours later Fed Chair Powell will have the opportunity to comment when he presents the first leg of his semi-annual testimony to the House Financial Services Committee. Later in the day, the Fed will also release its latest Beige Book of anecdotal reports. Meanwhile, bank earnings will again be a key focus for investors, with Bank of America, Blackrock, Citigroup, Wells Fargo and Charles Schwab reporting their latest quarterly results today.

Australia’s Westpac consumer confidence firms a little in July despite Sydney lockdown
Last month, Australia’s Westpac consumer confidence index fell 5.2%M/M to a five-month low as respondents, especially in the state of Victoria) reacted to the short-lived lockdown in Melbourne. This month, confidence has rebounded 1.8%M/M despite the more recent lockdown in Sydney, although it is worth noting that the survey was in the field before restrictions were tightened at the end of last week (and of course the survey does not catch today’s announcement of a two-week extension). According to Westpac, while sentiment amongst respondents from New South Wales was down sharply, this was more than offset by a lift in confidence in others states (notably Victoria and Western Australia, where pandemic-related disruptions came to an end). And despite the sharp decline this month, sentiment in New South Wales (and Australia has a whole) remains comfortably above the long-term average.

RBNZ leaves OCR at 0.25% but says will halt asset purchases by 23 July
The focus in New Zealand today was the RBNZ’s policy meeting, with investors waiting to see whether the Bank would sanction the market’s pricing of a first rate hike as soon as November this year. As it turns out, the RBNZ had little explicit to say about the outlook for the Official Cash Rate (OCR), which as expected remained at 0.25%. However, implicitly the Bank clearly sees a near-term tightening as a possibility, as today it announced that it would halt its Large Scale Asset Purchase Programme by 23 July – an abrupt end that was unsurprisingly a shock to the bond market. In its post-meeting statement, titled simply “Monetary Stimulus Reduced” the Bank noted that “some” ongoing monetary support was required to meet its remit, but that the current level of stimulus needed to be reduced to minimise the risk of overachieving its goals. Regarding the economy, the RBNZ acknowledged that recent data had been robust despite the ongoing impact from international border restrictions. So in the absence of any further significant downside shocks, beyond the coming short-term lift in inflation, more persistent pressure was likely to build over time due to rising domestic capacity pressures and growing labour shortages. The focus will now turn to Friday’s Q2 CPI to see whether that pressure is already becoming evident, necessitating a tightening as soon as this year – something that would be bound to drive the Kiwi dollar higher.

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