Japan's Q2 GDP lifted by consumer spending & investment

Emily Nicol

Delta worries drive markets at the beginning of the week; disappointing Chinese data also weighing on sentiment, at least outside of China
Despite news of a disappointing slump in the University of Michigan’s consumer sentiment index to new post-pandemic lows – indeed, the lowest reading in almost ten years – the S&P500 edged up 0.2% on Friday to end the week at a fresh record high. Instead, the market reacted to the decline in sentiment – likely due to concerns about rising delta variant virus cases and elevated inflation – by driving bond yields lower, with the 10Y note declining 8bps to 1.28%. The decline in bond yields weighed on the greenback, which erased the gains it had made the previous day.

Since reopening today, US equity futures have traded a couple of tenths lower amidst ongoing worries about the delta strain of the virus and some especially disappointing data in China. Concerns have been especially evident in Japan, where the TOPIX has declined 1.6% despite a stronger-than-expected local GDP report. Indeed, the GDP report may explain some of the concern, as the upside surprise to growth owed mostly to an unexpected lift in consumer spending, possibly resulting in the current wave of the virus, with almost 18,000 cases reported nationwide yesterday. In China, where July activity data heavily disappointed expectations and the PBoC’s 1Y MLF operation was conducted at an unchanged rate of 2.95%, the CSI300 is presently modestly in the red, with investors perhaps anticipating that more support will be forthcoming from policymakers (today’s MLF rolled over CNY600bn of the CNY700bn of maturing loans – more than might have been expected given the earlier RRR cut). However, stocks are down over 1% South Korea and Hong Kong. Most other markets in Asia are also at least slightly weaker.

In the Antipodes, Australia’s ASX200 has also closed with about a ½% loss and the 10Y bond yield has fallen 7bps, with New South Wales moving to a full state-wide lockdown on Saturday as authorities continued to struggle to get on top of the current virus outbreak (a further 415 cases were reported on Sunday). By contrast, the 10Y bond yield fell just 2bps in New Zealand, where the market continues to anticipate that the RBNZ will hike the OCR for the first time in seven years at Wednesday’s policy review.

Japan’s GDP expands 0.3%Q/Q in Q2 as both private consumption and business capex rebound despite pandemic challenges; net exports and inventories weigh on growth
The focus for investors in Japan today was on the preliminary national accounts for Q2, which pointed to much greater resilience in domestic demand during the quarter despite the ongoing challenges provided by the pandemic – resilience that unfortunately may help to explain current virus trends in Japan. According to the Cabinet Office, overall activity increased 0.3%Q/Q (1.3%AR) following a 0.9%Q/Q decline in output in the prior quarter that was 0.1ppt smaller than reported previously. This result was 0.2ppt firmer than Bloomberg’s consensus estimate. Given the 7.9%Q/Q slump in output in Q2 last year – also 0.2ppt smaller than estimated previously – this left output up a very flattering 7.5%Y/Y. More meaningfully, output remains 1.5% lower than in Q419.

In the detail, by far the largest surprise was the resilience of private consumption, which increased an unexpected 0.8%Q/Q following a 1.0%Q/Q decline in Q1 that is now 0.5ppt smaller than estimated previously. Spending on services increased 1.5%Q/Q following a 2.2%Q/Q decline in Q1, but remained down 6.5% compared with Q419. Spending on semi-durables increased 1.9%Q/Q but was 4.9% lower than in Q419. Meanwhile, spending on durables increased just 0.4%Q/Q and while up 8.7% since Q419 remained slightly lower than in the year leading up the consumption tax hike on 1 October 2019. It is worth noting that real compensation of employees declined 1.4%Q/Q in Q2. And while up 2.5%Y/Y, compensation was still 1.0% lower than in Q419 (private consumption fell 2.8% over this period).

In addition to the surprise increase in private consumption, today’s result also owed to a 1.7%Q/Q rebound in business investment that was 0.4ppt firmer than the consensus estimate, albeit following a 1.3%Q/Q decline in Q1 that is 0.1ppt larger than estimated previously. Of course, as usual we note that these figures are subject to the potential for significant revision once the Cabinet Office includes more accurate information from the MoF’s corporate survey (to be released 1 September). Other positive contributions to growth were made by a 2.1%Q/Q lift in residential investment (still down 2.8%Y/Y) and a 0.5%Q/Q increase in government consumption spending (up 3.4%Y/Y).

The largest drag on growth this quarter was net exports, which made a negative contribution of 0.3ppt – 0.1ppt larger than the consensus estimate. Overall exports increased a solid 2.9%Q/Q and so were up more than 26% from the especially depressed levels seen in Q220 but still slightly below the levels seen in Q419. While exports of goods increased 5.6% from Q419 levels, exports of services remained down 26% despite a 3.3%Q/Q increase in Q2 (the latter despite a further 6.9%Q/Q decline in spending by overseas visitors, which is now down more than 90% from Q419 levels). As signalled by trade data, imports increased a very robust 5.1%Q/Q in Q2 and so were up 5.2%Y/Y. Other expenditures to weigh on growth were a 0.2ppt negative contribution from private inventories (again subject to revision following the receipt of information from the aforementioned MoF corporate survey) and a 1.5%Q/Q decline in government investment.

Finally, unsurprisingly, the deflators continued to point to a very weak inflation pulse. The private consumption deflator declined 0.3%Q/Q and 0.4%Y/Y in Q2. Increased materials prices – as reflected in the PPIs – likely explains a 1.8%Q/Q increase in the residential investment deflator and a 0.6%Q/Q increase in the business investment deflator. The overall domestic demand deflator increased just 0.1%Q/Q and 0.6%Y/Y, while the overall nominal GDP deflator – not impacted by sharply higher import prices – fell 0.3%Q/Q and 0.7%Y/Y. As a result, nominal GDP increased just 0.1%Q/Q in Q2 (only just thanks to favourable rounding) and so remains about ¥17trn lower than the peak seen just ahead of the consumption tax hike.

Japan’s industrial production rebounds 6.5%M/M in June – more than first estimated
In today’s other Japanese economic news, final IP figures for June pointed to a more or less complete recovery in output following a 6.5%M/M slump in May. Total production is now estimated to have increased 6.5%M/M – 0.3ppt more than estimated previously – with small upward revisions to production of non-durable and durable consumer goods, as well as capital goods. Elsewhere in the report, the pickup in shipments was revised to 4.8%M/M – 0.5ppt larger than estimated previously. As a result, inventories increased 2.1%M/M – 0.2ppt less than estimated previously – and so were down 5.0%Y/Y. As always, the brand new content in today’s release concerned capacity utilization, which in aggregate increased 6.2%M/M in June after slumping 6.8%M/M in May. Firms’ productive capacity increased 0.1%M/M in June – the first increase since the onset of the pandemic – but was still down 1.0%Y/Y.

Trade data, machine orders, Reuters Tankan and CPI still to come in Japan this week
The remainder of this week features a number of further economic reports in Japan. Tomorrow the Tertiary Industry Activity Index should confirm a partial rebound in service sector activity in June as restrictions were eased, albeit only temporarily in Tokyo. On Wednesday, the focus will turn to the international merchandise trade report for July and machine orders figures for June. Annual growth in exports should slow somewhat to slightly less flattering levels as last year’s base effect begins to recede. After surprising to the upside last month, core machine orders are expected to have declined somewhat in June but remain well above last year’s pandemic-depressed levels. On Thursday, the Reuters Tankan for August is likely to continue to depict a yawning gap between the very positive business conditions enjoyed by manufacturers and the subdued conditions facing non-manufacturers. The week concludes with the release of the national CPI report for July, which is the first to be conducted under the new 2020 base weights. The updated base gave a much larger weight to spending on mobile phone charges, which recall fell very sharply back in April. So with the MIC revising data back to January this year, the BoJ’s preferred measure of core inflation – CPI excluding fresh food and energy – is now estimated to have declined 0.9%Y/Y in June. This is 0.7ppt weaker than reported under the old 2015 expenditure weights – a revision that was foreshadowed by the BoJ in the last Outlook Report. From that weaker level, the market anticipates only a fractional improvement in July given the guidance from last month’s release of advance data for the Tokyo area.

China’s activity indicators for July all weaker than expected, jobless rate nudges higher and home price inflation slows too
Turning to China, today saw the release of the country’s key domestic activity indicators for July, together with home price data for the same month. Unfortunately, all of these releases pointed to a greater slowdown in growth than analysts had expected, extending beyond what can be explained by declining base effects associated with the first wave of the pandemic. The disappointment is probably explained by increasing virus cases in China and elsewhere, together with ongoing supply chain disruptions and floods in central China.

Beginning with the industrial sector, total output increased just 0.3%M/M in July, which was weakest outcome since February last year. Annual growth slowed to 6.4%Y/Y from 8.3%Y/Y previously, which was a substantial 1.5ppts below the consensus expectation. For the year to date, industrial output increased 14.4%Y/Y following a 0.4%Y/Y decline a year earlier. In the detail, the slowdown was driven by the manufacturing sector where activity grew just 6.2%Y/Y in July compared to 8.7%Y/Y in June. Mining and quarrying activity grew just 0.6%Y/Y, which was similar to last month, while growth in power generation increased to 13.2%Y/Y. On an industry basis, unsurprisingly, the standout remained pharmaceuticals. But while output increased 25.3%Y/Y, this was more than 7ppts weaker than in June. Production of metal products grew 12.7%Y/Y – also 7ppts weaker than June – while growth in production of machinery and general equipment also slowed noticeably.

Turning to the demand side of the economy, growth in retail spending slowed 3.6ppts to 8.5%Y/Y in July – a substantial 2.4ppts below the consensus expectation. For the year to date, retail sales increased 20.7%Y/Y, coming off the back of a 9.9%Y/Y decline a year earlier. Growth in catering services slowed to 14.3%Y/Y from more than 20%Y/Y in June, while growth in spending on goods slowed to 7.8%Y/Y from 11.2%Y/Y previously. Meanwhile, investment spending on non-rural fixed assets increased 10.3%YTD/Y in July, which was down from 12.6%YTD/Y in June and 1.0ppts weaker than the consensus expectation. Growth in private sector investment slowed to 13.4%YTD/Y, whereas growth in state investment slowed to 7.1%YTD/Y. Manufacturing sector investment grew 17.3%YTD/Y, but this was down from 19.2%YTD/Y in June and comes after a 10.2%YTD/Y decline a year earlier. Slower growth was observed across almost all industries in the manufacturing sector. Property development increased 12.7%YTD/Y, which was down from 15.0%YTD/Y last month and also a little below market expectations. Finally, consistent with a sense that the economy was growing at a below trend-pace in July, the urban unemployment rate unexpectedly increased 0.1ppt to 5.1%.

In other soft Chinese news, new home prices across China’s 70 largest cities increased 0.3%M/M in July, marking the smallest increase since January. As a result, annual growth in prices slowed 0.2ppt to 4.1%Y/Y. Existing home prices increased an even softer 0.1%M/M, causing annual growth to slow 0.2ppt to 3.3%Y/Y. As in previous months, positive price pressure is much more intense in so-called first-tier cities, where new home prices increased 0.5%M/M in July. Prices for new homes in third-tier cities increased just 0.2%M/M, while prices for existing homes fell 0.1%M/M.

There are no further Chinese economic indicators scheduled over the remainder of this week.

Second estimate of euro area Q2 GDP due, along with employment and final July inflation
The euro area’s data calendar gets underway tomorrow with the second estimate of Q2 GDP. This is expected to confirm that the euro area’s economy expanded 2%Q/Q, 13.7%Y/Y. While this release will again merely provide an aggregate output figure, monthly construction activity figures for June – due the same day – will offer some further insight in the sectoral breakdown. Tomorrow will also bring quarterly employment numbers, which, in line with stronger GDP growth and relaxation of lockdown restrictions are likely to report a notable increase last quarter. Wednesday will bring revised July euro area inflation numbers. Not least due to base effects associated with Germany’s temporary tax cut in July 2020 and different timings of summer discounting, these are expected to confirm that the headline CPI rate rose 0.3ppt to 2.2%Y/Y, while core CPI moderated 0.2ppt to 0.7%Y/Y. German PPI numbers are due on Friday, while euro area balance of payments data for June are due on Thursday.

UK labour market, inflation and retail sales report due
There will be several top-tier UK data releases this week, with the latest labour market report tomorrow, July inflation figures on Wednesday and retail sales data on Friday. With the government’s Job Retention Scheme still in full operation in June and the economy posting another solid expansion that month, we expect to see a further tightening in labour market conditions, including a further notable increase in payrolls and vacancies and a modest drop in the unemployment rate. Meanwhile, growth in average labour earnings seems highly likely to rise further from the 7.3%3M/Y growth in May, supported in part by base and composition effects. Meanwhile, having jumped to 2.5%Y/Y in June, we expect a temporary easing in the headline CPI rate last month driven by a modest easing in non-energy industrial goods inflation, in part reflecting a change in seasonal price patterns. As such, core inflation might also briefly return back below the BoE’s 2% target. Focus at the end of the week will turn to July’s retail sales report, which might well reveal a drop in spending on goods at the start of the third quarter as the weather dampened visits to the High Street and spending on services increased as the final lockdown restrictions were eased.

Elsewhere, June ONS house price indices are due to be published on Wednesday, while public finance figures for July will be published alongside the GfK’s latest consumer confidence survey on Friday.

Focus in the US turns back to activity this week with tomorrow’s retail sales and IP reports key
This week’s US economic diary kicks off today with the New York Fed’s manufacturing survey for July. A busier day tomorrow will see the release of the retail sales and IP reports for July, together with the NAHB housing index for July and business inventory data for June. As far as the retail report is concerned, Daiwa America’s Mike Moran expects that a drop in auto sales will lead to a small 0.2%M/M decline in headline sales, but that ex-auto sales will increase 0.4%M/M. Meanwhile, Mike estimates a 0.4%M/M lift in IP in July with solid growth in the manufacturing and mining sectors more than offsetting a likely drop in utility output. Wednesday will bring the release of the minutes from last month’s FOMC meeting and housing starts and building permits data for July. With new home sales softening and inventories climbing, Mike expects that housing starts declined around 7%M/M. This week’s US dataflow concludes on Thursday with the release of the Philadelphia Fed’s manufacturing survey for July and the Conference Board’s leading indicator for July, with the latter likely to have posted its 14th gain in the last 15 months. The Fed speaking schedule is very light this week, with an appearance by Chair Powell in a town hall with educators unlikely to be market moving.

The economic focus in Australia this week is on the labour market
As far as economic data is concerned, the focus in Australia this week will be on the labour market. Most interest will probably centre on Thursday’s Labour Force report for July, which seems likely to portray a weakening of the labour market due mostly to the extended lockdown in Sydney. According to Bloomberg’s survey, the median analyst expects a 46k decline in employment and a 0.1ppt lift in the unemployment rate to 5.0%, although the range of estimates is understandably wide. A day earlier, the ABS will release the Wage Price Index for Q2, with an expected 0.6%Q/Q lift in wages (ex-bonus) likely to lift annual growth to 1.9%Y/Y – still well below the 3.0%Y/Y-plus rate that RBA Governor Lowe thinks will be required to sustain a CPI inflation rate comfortably inside the RBA’s 2-3% target band. Speaking of the RBA, the minutes from this month’s Board meeting are released tomorrow, but these seem unlikely to add much to the information conveyed at Governor Lowe’s recent parliamentary testimony and in the latest Statement on Monetary Policy.

The focus in New Zealand this week is on the RBNZ – a 25bp hike more than fully priced and investors looking for revised guidance on the policy outlook
In New Zealand, the sole focus of attention this week will be on Wednesday’s RBNZ policy announcement, at which the Bank will also release its latest Monetary Policy Statement (MPS) containing revised projections for the economy and policy settings. With the economy – including the labour market and inflation – much stronger than the RBNZ had expected just a matter of weeks ago, both investors and market commentators are convinced that the Bank will lift the OCR by 25bps to 0.50% (with a small risk that the Bank lifts the OCR by 50bps). This would follow the Bank’s decision at last month’s policy meeting to halt the QE programme abruptly. Assuming that the RBNZ acts as expected – we cannot rule out the possibility that recent virus developments in Australia and Asia will have spooked the Bank – attention will quickly turn to the Bank’s revised policy guidance, with both the MPS and the Governor’s post-meeting press conference likely to cast light on the likelihood of further action over coming meetings. Aside from the RBNZ, the only other diary entry of passing interest this week is the Q2 PPI, which along with other business price indicators is released on Wednesday.

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