UK inflation falls more than expected

Emily Nicol

Wall Street sinks as retail sales disappoint, but Asian markets firmer today; Aussie stocks underperform amidst record virus cases; RBNZ retains OCR at 0.25% due to virus outbreak
While on Monday Wall Street had shrugged off disappointing Chinese data, a less buoyant New York Fed manufacturing survey and delta-variant virus worries, yesterday the wind was taken out of the market’s sails by news of a disappointing 1.1%M/M decline in US retail sales during July. So despite a firmer than expected July IP report, a decline in consumer discretionary stocks led the S&P500 to a 0.7% loss. Meanwhile, increased risk aversion helped drive the greenback to a one-month high, while the 10Y Treasury note closed little changed at 1.26%.

Since the close, US equity futures have inched a little higher as investors in the Asia-Pacific region appeared less bothered by the virus-related risks that had weighed earlier in the week. In Japan, following yesterday’s confirmation of an extension to the duration and geography of emergency virus measures, the TOPIX has closed with a 0.4% gain. The local data flow was slightly mixed, as an encouraging machinery orders report for June was countered by news that exports had fallen short of expectations in July (albeit, as noted below, the BoJ’s estimates still point to growth in real terms). Elsewhere in Asia, broadly similar gains were recorded in Hong Kong, South Korea and Singapore, while mainland China saw gains of more than 1%.

Turning to the Antipodes, Australia’s ASX200 and AGCB bond yields are little changed amidst news of disappointingly low wage growth in Q2 and a record-breaking 633 new virus cases in New South Wales (a further 24 cases were reported in the state of Victoria and 22 cases in Canberra). Meanwhile, in New Zealand the RBNZ surprised the market by leaving the OCR at 0.25% – a decision that was made in the context of yesterday’s Government decision to place the country into a snap national lockdown (with further virus cases discovered since). However, an initial decline in the Kiwi dollar and bond yields proved short-lived – the 10Y bond eventually closing up 6bps – with the RBNZ’s commentary and projections making clear that policy tightening is still expected before the end of this year, with a further 100bps of tightening forecast for next year.

Japan’s nominal exports disappointingly flat in July, but BoJ estimates still point to a lift in real exports; imports decline for the first time since November
As far as data were concerned, a key focus in Japan today was the release of merchandise trade figures for July. Somewhat disappointingly, in seasonally adjusted terms, Japan’s goods export receipts were unchanged from June. So combined with the impact of dwindling base effects, annual growth slowed to a still flattering 37.0%Y/Y from 48.6%Y/Y previously – an outcome that was a little weaker than the consensus expectation. More meaningfully, the level of exports in July remained about 11% above the pre-pandemic level in February 2020. Not surprisingly, generally the strongest annual growth rates continued to be recorded by those industries that had fared worst a year earlier, with exports of transport equipment increasing nearly 45%Y/Y and so accounting for around a quarter of the total rebound in exports over the period. Exports of manufactured goods increased 55.1%Y/Y, while exports of machinery and electrical machinery increased 35.8%Y/Y and 30.9%Y/Y respectively.

Meanwhile, after a solid increase in June, import values declined 1.6%M/M in July – the first pullback since November last year. As a result, annual growth in imports slowed unexpectedly to 28.5%Y/Y from 32.7%Y/Y in June. More than a third of that annual growth was due to a near-80%Y/Y rebound in imports of mineral fuels, with imports of petroleum more than doubling. A more than 63%Y/Y rebound in of other raw materials – especially iron ore – made a further large contribution, with growth exaggerated by the past year’s rebound in global commodity prices. With the negative surprise in imports exceeding that for exports, an unadjusted trade surplus of ¥441bn was more than double market expectations and slightly larger than that recorded in June. However, the seasonally-adjusted surplus of ¥53bn was slightly smaller than the consensus estimate, but was still a lift from the small deficit reported the previous month.

As usual later in the day, the BoJ released its analysis of the export and import data, helpfully adjusting the MoF’s statistics to remove the influence of both seasonality and changing prices. Happily, the BoJ’s estimates cast exports in a stronger light, with volumes assessed to have increased 1.7%M/M in July. Given base effects, real exports were up 25.2%Y/Y and 8.3% compared with February 2020. More importantly for early Q3 GDP calculations, real exports in July were 2.1% above the average monthly level in Q2. Meanwhile, the BoJ estimates that real imports declined 2.4%M/M in July, causing annual growth to slow slightly to 7.5%Y/Y. Moreover, this means that real imports in July were also 2.4% below the average monthly level in Q2. As a result, whilst very early in the quarter, net merchandise exports are presently tracking positively.

The BoJ will release more details regarding the commodity breakdown and destination of these exports next week. In the meantime, the MoF’s own volume estimates indicate that exports to the US grew just 19.5%Y/Y, which was down sharply from rates of close to 80%Y/Y over the previous two months. Exports to the EU increased 39.9%Y/Y, which was up from 25.8%Y/Y in June but follows a 36.9%Y/Y decline in July last year. Exports to Asia grew 20.4%Y/Y, with exports to China increasing just 12.1%Y/Y – the latter the least since February, but with exports already far above the average level during the months leading up to the pandemic.

Japan’s core machinery orders decline modestly in June; rise solidly in Q2 with firms forecasting a large lift in Q3
Today’s other key Japanese economic news concerned machinery orders. Following two months of strong growth, total machinery orders declined 6.6%M/M in June, in large part due to a 10%M/M decline in foreign orders. With last June representing the pandemic low-point, total orders increased a very flattering 43.1%Y/Y with foreign orders rising by more than 111%Y/Y. More meaningfully, orders increased 3.8%Q/Q in Q2 and were 14% higher than the average level through 2019.

Importantly, the closely-followed measure of core private domestic orders (which excludes volatile items such as ships and capex by electricity companies) declined a smaller than expected 1.5%M/M in June following three consecutive months of growth. As a result, these orders grew 18.6%Y/Y, once again flattered by base effects. More meaningfully, core orders increased 4.6%Q/Q in Q2 – presumably helping to underpin the positive business capex figure reported in Monday’s GDP release. And while orders were sadly still 3.8% lower than the average level through 2019, growth did exceed the 2.5%Q/Q forecast made by machinery-producing firms at the beginning of the quarter. Within the detail, orders from the private manufacturing sector increased 3.6%M/M in June and so were up more than 30.0%Y/Y. Much of the lift was due to an increase in orders from the non-ferrous metals industry. Core orders from the private non-manufacturing sector increased 3.8%M/M, in part due to an increase in orders from the construction and information services sectors, and were up almost 10%Y/Y. Government orders increased 3.1%M/M in May but were 23.2% below the unusually high level recorded a year earlier.

Finally, and most encouragingly, the Cabinet Office’s updated survey of machinery-producing firms’ expectations for the present quarter reported a forecast 3.9%Q/Q lift in total orders and an especially encouraging 11.0%Q/Q lift in core private domestic orders. Of course, in light of the worsening virus picture in Japan and elsewhere, it is possible that these forecasts could prove too optimistic.

Downwards surprise to UK inflation due in part to base effects
While UK inflation was expected to have moderated in July, today’s data surprised on the downside, with the headline CPI rate falling 0.5ppt to 2.0%Y/Y, more than reversing the jump in June. While energy inflation moderated slightly (down 1ppt to 9.3%Y/Y), the drop principally reflected softer services (down 0.5ppt to 1.6%Y/Y) and non-energy industrial goods inflation (down 0.4ppt to 2.4%Y/Y). As such, core inflation also fell 0.5ppt to 1.8%Y/Y, down from the near-3½ year high in June.

But the ONS attributed almost half of the moderation to base effects caused by the jump in prices last year when the economy emerged from lockdown. Certainly, changing seasonal discounting patterns including a higher base this time last year played a role in clothing inflation this month, which fell 1.3ppts to 2.0%Y/Y. A pandemic-related change in the timing of demand of certain recreational goods also weighed on inflation – e.g. prices of data processing equipment such as routers and web cams – while prices of package holidays were also estimated to have declined this year compared with a rise in July last year. Similarly, the hospitality component was impacted by the higher base last year when the economy emerged from lockdown.

This was in part counterbalanced by a higher contribution from transport inflation (up 0.5ppt to 7.7%Y/Y), the most since November 2011. Indeed, prices of second-hand cars (up 14.4%Y/Y after a rise of just 0.9%Y/Y in May) was again a notable driver of higher inflation – the largest contribution since May 2010 – seemingly reflecting increased demand following the reopening of the economy, together with the supply bottlenecks impacting production of new autos. There were also reportedly concerns about reduced supply of second-hand cars due not least to fewer one-year-old cars coming to the market because of fall in new registrations last year. Inflation of new cars, however, fell back again by 0.7ppt to 2.5%Y/Y.

In contrast to the CPI data, the industrial producer price inflation figures for July surprised on the upside. Indeed, input prices of materials and fuels rose 0.8%M/M, following an upwardly revised increase of 0.5%M/M previously due in part to the basket weight changes implemented. This saw the year-on-year increase in input producer prices rise 0.2ppt to 9.9%Y/Y, Producer output prices rose 0.6%M/M, to leave the equivalent annual rate of inflation also up by 0.4ppt to 4.9%Y/Y, the highest rate since December 2011.

Final July inflation data and June construction figures ahead in the euro area
Today will also bring revised July inflation numbers for the euro area. The preliminary release showed that, despite a jump in German inflation last month (up 1ppt to 3.8%Y/Y) due to base effects associated with the temporary tax cut in July 2020, the headline euro area CPI rate rose a more modest 0.3ppt to 2.2%Y/Y. This in part reflected different timings of summer discounting. And with energy inflation accounting for a sizeable contribution, core CPI actually moderated 0.2ppt to 0.7%Y/Y. Construction output figures for June will also be released today.

FOMC minutes to be read carefully in the US today; housing starts and building permits data also due
Today will bring the release of the minutes from last month’s FOMC meeting and housing starts and building permits data for July. The former will be read carefully for any clues regarding what Chair Powell may discuss at next week’s Jackson Hole symposium. Meanwhile, with new home sales softening and inventories climbing, Daiwa America’s Mike Moran expects that housing starts likely declined around 7%M/M.

Australian wage growth remains weak in Q2, supporting the RBA’s dovish policy outlook
In recent times, RBA Governor Lowe has argued that a return to wage growth of over 3%Y/Y is likely to be required if CPI inflation is to move back inside the Bank’s 2-3%Y/Y target range on a sustained basis. Lowe has also argued that despite the rapid recovery in the economy and the retightening of the labour market, the resulting pick-up in wage growth is likely to be slow. Today’s release of the Wage Price Index for Q2 supported the Governor’s latter argument.

The headline Wage Price Index – which is measured excluding bonus payments – increased just 0.4%Q/Q. This outcome was 0.2ppt below the consensus expectation and less than the 0.6%Q/Q increase recorded in the two prior quarters. Annual growth in wages still nudged up 0.2ppt to a still-weak 1.7%Y/Y, reflecting the especially soft readings in the middle quarters of last year. In the detail, private sector wages grew 0.5%Q/Q in Q2, which was also less than in the prior two quarters. Public sector wages increased 0.4%Q/Q for a third consecutive quarter. Compared with a year earlier, private wages increased 1.9%Y/Y and public sector wages increased 1.3%Y/Y. It is worth noting that private wage growth looks only marginally firmer once bonuses are included, with annual growth rising 0.1ppt to 2.0%Y/Y.

Attention will now turn to tomorrow’s Labour Force survey for July – the first report to capture the impact of the extended lockdown in Sydney.

RBNZ leaves OCR at 0.25% citing the Level 4 lockdown, but signals tightening expected once current uncertainty removed
With New Zealand yesterday placed into a very strict nationwide lockdown following the first community virus case in six months – since confirmed to be of the delta variant and followed by news of further cases – today’s RBNZ monetary policy decision was awaited with heightened interest. As it turns out, the RBNZ elected to maintain the Official Cash Rate (OCR) at 0.25%, providing a considerable surprise to a market that was still largely priced for a 25bp rate hike even after yesterday’s news (and had earlier contemplated the possibility of a larger hike).

In the press statement and subsequent press conference, the RBNZ made clear that the decision had been made in the context of the Government’s decision to initiate the lockdown. Looking ahead – once the outbreak is brought under control and current heightened uncertainty is diminished – the Bank’s assessment is that the “…least regrets policy stance is to further reduce the level of monetary stimulus so as to anchor inflation expectations and continue to contribute to maximum sustainable employment”. The post-meeting statement argued that recent data for the economy suggest robust and broadening demand, despite some weakness persisting in the sectors most exposed to international tourism. As a result, capacity pressures had become evident in the economy, particularly in the labour market where job vacancies remain high despite the recent decline in unemployment and underemployment. Moreover, wages were said to be rising consistent with the tight labour market conditions. Broader inflation pressures were described as being accentuated in the near-term by one-off price rises such as higher oil prices, and temporary factors such as supply shortfalls and higher transport costs.

The formal projections in the accompanying Monetary Policy Statement provide some guidance regarding the RBNZ’s current policy outlook. Importantly, while the bulk of the economic projection was finalised a week ago, the projection for the OCR was only finalised today, to be consistent with today’s decision – one that was presumably not the one expected a week ago. The published baseline projection assumes a single 25bp rate hike before the end of the year, which depending on the evolution of the virus outbreak could occur at either of the October or November meetings. Thereafter, a further 100bps of tightening is forecast in 2022, with a further modest tightening beyond that to lift the OCR to around 2%. Based on these forecasts, CPI inflation is forecast to recede from an expected peak of just over 4%Y/Y this year to 2.2%Y/Y by the second half of next year and 2.0%Y/Y by the middle of 2024.

In today’s other Kiwi news, Statistics New Zealand reported that the PPI inputs index jumped 3.0%Q/Q in Q2, in part due to sharply higher prices for fuel and electricity, lifting annual inflation to 5.9%Y/Y. The PPI outputs index also increased a substantial 2.6%Q/Q – led by steep increases in dairy, fuel and electricity prices – and so lifting annual inflation to 4.0%Y/Y.

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