ECB likely to slow pace of asset purchases in Q4

Chris Scicluna

Risk off in equity markets as near-term growth expectation moderated by Delta
While US job openings unexpectedly surged to a new record high in July, markets exhibited a slight risk-off tone on Wednesday. Of note, the Fed’s Beige Book reported that economic growth had “downshifted slightly to a moderate pace in early July through August”, with the deceleration said to be largely attributable to a pullback in dining out, travel, and tourism, reflecting safety concerns due to the rise of the Delta variant, and, in a few cases, international travel restrictions. So the S&P500 closed down 0.1% – a third consecutive decline but just 0.4% in total – and the post-payrolls lift in bond yields took a breather with the 10Y note trading down 3bps to 1.34%. In other Fed news, the Dallas Fed’s Kaplan reiterated his support for the Fed to start to taper asset purchases from October, notwithstanding a downgrade to his forecast for GDP growth this year. The New York Fed’s Williams said while the taper could start this year if the economy performs as he expects, he wants to see more improvement in employment before declaring that it has been met the test of “substantial further progress”.

The tone in markets has become risk-off during today’s Asia-Pacific session, with US equity futures presently several tenths lower and the 10Y note fractionally lower in yield too. As a result, an eight-day winning streak has ended in Japan, with the TOPIX declining 0.7% on the day without any major local data. Probably not helping matters, Economy Minister Nishimura confirmed that Japan will extend state of emergency conditions in 19 prefectures until the end of this month – these had been set to expire on Sunday – with PM Suga expected to announce this formally in a press conference at 7pm local time. Nishimura did express the hope that some easing of restrictions would be possible subsequently thanks to expected further progress on vaccination. Following yesterday’s confirmation that Sanae Takaichi will contest the LDP leadership election – and promising to freeze the goal of achieving a zero primary fiscal balance until inflation rises to 2% – investors continue to await confirmation that vaccine minister Taro Kono will also enter the race.

Elsewhere in Asia, equity markets are similarly weaker in Mainland China with the August inflation reports pointing to greater than expected price pressures at the producer level but weaker than expected inflation for consumers. However, with stock in troubled developer Evergrande falling over 9% to a six-year low, and Tencent down more than 6% on news that Chinese regulators had pressed gaming developers to place less emphasis on profits, the Hang Seng is presently down almost 2%. Meanwhile, an overnight drop in the price of iron ore has seen mining stocks contribute to a decline of almost 2% in the ASX200 to a more than five-week low, while the 10Y AGCB has tracked the decline in UST yields. In virus news, the Premier of New South Wales said that stay-at-home orders would be lifted for fully vaccinated people, but only once 70% of the population is fully vaccinated. New South Wales recorded 1,405 new virus cases today, while cases in Victoria increased to a new high of 324. New Zealand moved closer to virus elimination – at least for a while – with just 13 cases reported today, buying it time to continue to ramp up its previously slow vaccination progress with new doses sourced from Spain.

Japan’s broad money growth slows to 4.2%Y/Y in August as base effects wane; Tokyo office vacancy rate beginning to plateau, but rentals still falling
As with yesterday’s bank lending figures, today’s release of the monetary aggregates for August pointed to slower growth as the base effects associated with the first wave of the pandemic continued to wear off and the economy settles back towards a slow rate of trend growth. According to the BoJ, M3 expanded at an annualised pace of just 3.1% during the month, compared with 8.6%M/M% in August last year. As a result, annual growth in M3 slowed to a 15-month low of 4.2%Y/Y from 4.6%Y/Y previously. Similarly, M2 grew at an annualised pace of just 2.6% in August, and so annual growth slowed to 4.7%Y/Y from 5.3%Y/Y previously.

In other news, the office vacancy rate in the Tokyo business area increased a further 0.03ppts to 6.31% in August, marking the highest level since June 2014 (and well above the long-run average of 5.4%). However, this was the smallest increase since March last year, perhaps indicating that the change in working habits bought on by the pandemic might be close to running their course. The high vacancy rate is continuing to weigh on office rental rates, however, which for buildings more than a year old fell a further 0.5%M/M in August – the thirteenth consecutive decline. As a result, these rates are now down a cumulative 8.6% from the July 2020 peak.

China’s PPI inflation unexpectedly rises in August, but CPI inflation unexpectedly moderates
Today China released both the PPI and CPI reports for August. Beginning with producer prices, driven by continued growth in commodity prices and increased costs associated with supply bottlenecks, the overall PPI output index increased 0.7%M/M. This marked the largest increase since May and meant that annual inflation unexpectedly increased 0.5ppts to a new 13-year high of 9.5%Y/Y (the consensus expectation was that annual inflation would remain steady). Prices increased a further 3.0%M/M in the mining sector, lifting annual inflation to almost 42%Y/Y. Meanwhile, prices for other raw materials increased 0.9%M/M and 18.3%Y/Y. Some of that pressure is being transferred to firms downstream, with the price of manufactured producer goods increasing 0.7%M/M in August, lifting annual inflation by 0.5ppts to 8.0%Y/Y – the fastest pace seen in data stretching back as far as 1999. However, there was again little evidence of rising input prices materially affecting factory gate prices for the consumer. Indeed, the PPI for consumer goods was unchanged in August and so up just 0.3%Y/Y, with even that low level of inflation mostly due to a 0.9%Y/Y lift in food prices. Prices for durable consumer goods declined 0.2%M/M in August and so were down 0.1%Y/Y.

The subdued inflation in consumer goods prices at the PPI level was also again evident in the CPI, which in contrast to the PPI fell short of the consensus expectation. The headline index increased just 0.1%M/M in August, which given base effects caused annual inflation to ease 0.2ppts to 0.8%Y/Y – 0.2ppts below the consensus expectation. The soft result occurred notwithstanding a 0.8%M/M lift in food prices – nonetheless still down 4.1%Y/Y – led by a sharp lift in prices for fresh vegetables. By contrast, after increasing 0.5%M/M last month – albeit partly due to higher energy prices – non-food prices declined 0.1%M/M in August, causing their rate of inflation to slow 0.2ppts to 1.9%Y/Y. The small decline in non-food prices during the month owed to slightly lower prices for energy (automotive fuel prices declined 1.7%M/M but were still up over 22%Y/Y. As a result, the core CPI, which excludes both food and energy, was unchanged during the month, lowering annual inflation by 0.1ppts to just 1.2%Y/Y – far below the PBoC’s target of 3% annual inflation and so clearly no obstacle to the PBoC delivering further targeted stimulus to the economy.

ECB likely to slow pace of PEPP net purchases close to pace at start of the year and revise up near-term GDP and inflation forecasts
Today’s main event will undoubtedly be the outcome of the ECB’s latest monetary policy meeting at lunchtime. The Governing Council will be presented with updated economic projections. And based on these, coupled with an assessment of financial conditions, it will give an indication of the expected pace of PEPP purchases over the coming quarter. We do not, however, expect to learn anything conclusive about the pace and nature of asset purchases beyond the end of this year.

With respect to the ECB’s economic projections, upwards revisions to the near-term profiles of GDP and inflation from those forecast in June now look to be in order. Despite ongoing challenges with supply bottlenecks and the delta variant, following upwards revisions to the estimate of economic output in the first half of the year, the ECB’s GDP forecast for 2021 of 4.6%Y/Y now looks some ½ppt too soft, while the projections of 4.7%Y/Y and 2.1%Y/Y in 2022 and ‘23 respectively might be nudged down only slightly. Given recent outturns, including the jump to 3.0%Y/Y in August, as well as ongoing pressures on energy prices, the projection for inflation this year (1.9%Y/Y) will also be revised up, and above the ECB’s 2.0% target. However, as there remain no significant second-round effects on wages or expectations, the inflation projections for both 2022 and ‘23 (1.5%Y/Y and 1.4%Y/Y respectively) should be little changed. So, in light of the ECB’s rate guidance, the inflation outlook will still be incompatible with no tightening over the horizon.

The aim of the PEPP purchases, however, is to “maintain favourable financing conditions” throughout the pandemic. And with market interest rates lower than in June when the pace of purchases for Q3 was agreed, and less sovereign bond issuance to come than over recent quarters, there appears scope for a modest slowing in the pace of PEPP purchases in the coming quarter from the average rate between €75-80bn per month conducted throughout Q2 and so far in Q3. So not to risk a marked correction in periphery bonds, however, the Governing Council might wish also to commit to maintaining net purchases no lower than the rate close to €60bn per month conducted in Q1. So, the extent of any slowing in purchases, if at all, will likely be modest.

German exports up for 14th successive month but imports down sharply in July following firmer growth in prior months
On another quiet day for euro area economic data, this morning brought German merchandise trade data for July. The value of goods exports extended its upwards trend, rising for a fourteenth successive month, up 0.5%M/M following growth of 1.3%M/M in June. That left exports up 12.4%Y/Y and 1.6% above the pre-pandemic level in February 2020. In contrast, German imports fell back in July, dropping a steep 3.8%M/M to a three-month low. Given stronger growth earlier in the year, however, imports were still up 16.6%Y/Y and were 5.9% above the pre-pandemic level. Contrary to expectations of a drop in July, Germany’s goods trade surplus rose almost €2bn to €18.1bn, a four-month high and firmly in the top half of the Covid-era range.

REC survey suggests hiring activity in UK picks up further in August while labour supply shortages further intensify; RICS survey suggests UK housing market slows but home prices are expected to keep rising
At yesterday’s Treasury Select Committee hearing, BoE Governor Bailey acknowledged that the UK economic recovery appeared to be levelling off, with labour supply shortages acting as one key restraint on activity. Two second-tier surveys released overnight added a little colour. The REC report on jobs – which reflects the views of recruitment and employment consultancies – signalled a further marked pickup in hiring activity last month, with permanent placement growth at a series high and temp billings also up significantly. So, total vacancies reportedly slowed only slightly from July’s record pace. But – despite still some 2mn more workers unemployed, on furlough or currently inactive compared to before the pandemic – labour and skill shortages were reported to have become even more acute, with candidate availability at a series low. So, the resulting heightened competition for workers pushed starting salaries for permanent staff up at a record rate, with an accelerated pace of pay growth reported for temps too.

Meanwhile, the RICS residential market survey reported that the number of home sales fell for a second successive month in August and the pace of house price growth eased somewhat too, reflecting not least the tapering of the government’s stamp duty holiday. However, while new buyer enquiries also fell again, with new instructions and the inventory of homes on the market also low, prices were expected to continue to rise over coming months albeit at a softer pace than of late. And over the coming three months, sales are expected to stabilise before returning to modest growth over the coming year.

Another quiet day ahead in the US
Following yesterday’s small burst of economic data and Fed commentary, the slumber resumes in the US today with the weekly jobless claims report the only entry of note in the economic diary.

Kiwi activity data points to strong lift in GDP in Q2
Ahead of next week’s release of the national accounts, today Statistics New Zealand released business financial data casting further light on activity during Q2. Of particular note, the value of manufacturing sales increased a very strong 3.9%Q/Q. However, in aggregate, that growth was due to a very sharp lift in prices – especially for dairy product – and so volumes declined 0.1%Q/Q, largely due to lower volumes of petroleum and coal. However, the news from the wholesale trade sector was unambiguously positive, with the value of sales increasing 3.0%Q/Q, with strong growth seen across the sector. While much smaller in absolute size than the manufacturing and wholesale trade sectors, higher prices for forestry product helped generate a huge 17.5%Q/Q lift in sales, while double-digit growth was also reported across a number of services industries including transport/warehousing, recreation and administrative support. So all up, the economy has probably grown at a similar pace to the very strong 1.6%Q/Q advance posted in Q1. Of course, given the current virus outbreak, GDP is likely to post a temporary decline of at least 5%Q/Q in the current quarter.

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