BoE Chief Economist says November meeting is live for rate hike

Chris Scicluna
Emily Nicol

Bond sell-off resumes as breakevens signal inflation worries, but S&P500 hits record high; Intel weighs on sentiment after close, but Evergrande said to make a coupon payment
The sell-off in the US Treasury market resumed yesterday, with the 10Y UST yield rising 4bps to 1.70% – the highest close since the end of March. The sell-off – which was even greater at the front of the curve – was clearly driven by rising concerns about inflation, with the 10Y breakeven rate rising a further 5bps to a 15-year high of 2.65%. Even so, positive earnings reports from the likes of Tesla allowed the S&P500 to advance 0.4%, thus surpassing the previous record high set in early September.

Sentiment soured a little after the close – and indeed Nasdaq futures remain down 0.4% as we write – after Intel forecast lower sales and a reduced profit margin due to clients struggling with component shortages (the stock declined 9% in extended trade). Partially offsetting that news, China’s state-backed Securities Times reported that China Evergrande Group had made a coupon payment originally due on 23 September, thus just inside the one-month grace period. However, the 10Y UST yield has still traded a couple of basis points lower in Asia.

Against that background, it has been a mixed session for the major bourses in Asia. In Japan, where the flash October PMIs provided some good news – with output returning to expansion amidst the removal of state of emergency conditions – the TOPIX ended the day near yesterday’s closing level to be down a little more than 1.0% over the week. However, with the PMIs also pointing to intensifying price pressures – albeit still extremely muted in today’s CPI report – the trend weakening in the JGB market has continued, with the 10Y yield rising above 0.09%. In mainland China, the CSI300 advanced almost 0.6% on the day to be up 0.5% on the week while the Hang Seng has gained 0.3% on the day but 3.0% over the week. The tech-heavy Taiwan and South Korean markets are little changed on the day.

In the Antipodes, Australia’s flash October PMIs also provided good news, like those in Japan indicating a return to growth in output as pandemic restrictions on activity begin to ease. Combined with overnight developments in USTs, this caused Aussie bonds to weaken, with the rise in yields at the short-end prompting the RBA to act to defend its 0.1% target for the April 2024 bond, making its first purchase of this security since February. While the RBA’s action caused the yield on that bond to fall 5bps to 0.12%, the yield on the 10Y AGCB has continued to march higher, rising 4bps to 1.83% – now not far below the highs reached earlier this year and about 75bps higher than it stood in mid-August. So, despite the firmer PMI data, Aussie stocks are also little changed today.

Japan’s composite PMI signals expansion in October for the first time since April despite worsening supply bottlenecks and price pressures
With virus cases having receded substantial from the record high levels seen in August, and state of emergency conditions in many prefectures removed at the end of last month, today’s Japanese flash PMIs for October cast the economy in a much stronger light than in recent months. In particular, building on a 2.4pt improvement last month, the composite PMI output index increased by a further 2.8pts to 50.7 in October – the first expansionary reading since April and above 50 for only the second time this year.

Predictably, the largest contributor to the overall improvement this month was the service sector. Indeed, the headline services index – the business activity index – increased by a further 2.9pts to 50.7. This marks the highest reading since January 2000 and is almost 8pts firmer than the low seen back in August. The new orders index also improved 1.6pts, but remained slightly contractionary at 49.7. Less positively, the employment index fell 1.5pts to a barely expansionary 50.1. However, the business expectations index, which has tracked above average levels for more than a year, nudged up 0.1pts to 58.1. On the pricing front, the input prices index increased 1.1pts to a pandemic high of 51.1, while the output prices index increased 0.9pts to 51.2, so also at its highest level since January last year.

The flash manufacturing PMI also cast the factory sector in better shape, notwithstanding worsening supply-chain strains. The headline manufacturing PMI increased 1.5pts to 53.0 – a level last reached in July. The detail remained somewhat softer than the headline index might suggest ordinarily. Despite rebounding 2.6pts, the output index stands at a comparatively subdued at 50.7. The new orders index firmed 1.8pts from last month’s nine-month low to 51.2, while the new exports orders index increased 0.5pts to a three-month high of 51.0. Intensifying supply bottlenecks were evident in the supplier deliveries index, which declined 0.4pts to 38.0 – the lowest level since that recorded in the aftermath of the huge Tohoku earthquake and tsunami in 2011. In addition, the input prices index increased 1.2pts to 69.2 and the output prices index increased 1.2pts to 56.1 – in both cases the highest readings since 2008.

Japan’s headline CPI rises 0.2%Y/Y in September – first positive reading in 13 months; the BoJ’s preferred core measure still down 0.5%Y/Y, weighed down by mobile call charges
The other key report in Japan today was the national CPI for September, although as usual this printed close to the consensus expectation following the guidance provided by the earlier release of advance data for the Tokyo area. The headline CPI index increased 0.4%M/M in seasonally adjusted terms, thus lifting the annual inflation rate by 0.6ppts to 0.2%Y/Y – the first positive reading since August last year and exactly in line with the consensus forecast. Sadly for the BoJ, as the Tokyo CPI had suggested, most of the lift in the CPI was due to an 8.2%M/M rebound in the price of fresh food – largely due to higher vegetable prices – which as a consequence is now up 2.2%Y/Y. As a result, the BoJ’s forecast measure of core inflation – which excludes fresh food – increased by a much smaller 0.1%M/M. This was sufficient to lift annual inflation by 0.1ppts to 0.1%Y/Y – the first positive reading since March last year and in line with the consensus estimate.

However, after pausing last month, the upward trend in energy prices resumed in September, with a 0.9%M/M increase lifting annual growth in these prices to 7.4%Y/Y. And so, unfortunately, the BoJ’s preferred core measure – which excludes both fresh food and energy – indicated no change in prices in September. This left the BoJ’s preferred measure down a steady 0.5%Y/Y, which was 0.1ppt weaker than the consensus estimate. The even narrower measure of core inflation used overseas – which excludes all food and energy – weakened 0.1ppt to -0.8%Y/Y. Of course, all of these measures have been impacted by the huge decline in mobile call fees seen back in April, which subtracted about 1.2ppts off annual inflation. Netting out this impact and the impact of the rebound in energy prices, we would continue to characterise the inflation trend as being very modestly positive, as was indicated by the 0.3%Y/Y increase in the BoJ’s measure of the trimmed mean in August (the BoJ will update this measure for September on Tuesday).

Elsewhere in the detail, total goods prices increased by a seasonally-adjusted 0.6%M/M – clearly driven by higher food and energy prices – and so were up 1.8%Y/Y (1.7%Y/Y excluding the price of fresh food). Industrial goods prices increased 1.4%Y/Y for a third straight month, but fell 0.1%Y/Y excluding the impact of higher energy prices. Prices for household durable goods – which had increased markedly around the middle of this year – declined 2.4%M/M in September, causing annual inflation for these items to slow 2.3ppts to 3.0%Y/Y. In the services sector, prices were stable in September in seasonally-adjusted terms, causing the annual decline in prices – driven by the aforementioned reduction in mobile calling fees – to increase 0.1ppt to 1.4%Y/Y. Prices for recreational services increased a seemingly sturdy 6.1%Y/Y, but this follows a 4.7%Y/Y decline last September when prices were lowered artificially by the government’s ill-fated “Go-to” travel and hospitality subsidy programme. The BoJ will hope that the resumption of growth and tight labour markets begins to lift wages growth over coming quarters (and more likely years), as will be necessary if service sector inflation is to approach levels consistent with its overall CPI target.

After more hawkish comments from the BoE, UK retail sales fall for fifth successive month and consumer confidence falls to an 8-month low; flash UK October PMIs still to come
The flow of hawkish commentary from BoE staff members continued yesterday evening with Chief Economist Huw Pill telling the FT that the 4 November MPC meeting is “live” for a possible rate hike. Stating that he “would not be shocked” if inflation rose “close to or even slightly above 5%” early next year, he noted that such an increase would be “uncomfortable” for the BoE. And while inflation would also likely come down later in the year, he considered the labour market to be “quite tight” even after the end of the government’s furlough scheme, and judged that “we don’t need the emergency settings of policy that we saw after the intensification of the pandemic”. So, while he said that next month’s policy decision will be “finely balanced”, and he did not see “a need to go to a restrictive [policy] stance”, it seems that he is itching to raise rates.

Nevertheless, as suggested by this morning’s UK economic data, growth momentum in the UK continues to fade. Indeed, today’s UK retail sales figures once again came in weaker than expected, with the volume of sales down for the fifth consecutive month in September (-0.2%M/M) to mark the longest losing streak since the series began in early 1996. And that figure was flattered by the surge in spending at petrol stations (2.9%M/M) amid panic-buying at the end of the month. Excluding that impact, the decline in retail sales was even steeper (-0.6%M/M). Within the detail, the drop in sales in September was driven by notable falls in spending at household goods stores (-9.3%M/M) and other non-food stores (-1.7%M/M) as demand for furniture and sporting goods continued to wane following strength throughout the pandemic. Spending at clothing stores improved (+4.3%M/M), but this level was still roughly 5½% lower than before the pandemic and down more than 3½%Q/Q. Overall, there was a marked decline in the volume of total sales over the third quarter as a whole, by a whopping 3.9%Q/Q in Q3 (-4.9%Q/Q when excluding auto fuels). Admittedly, this followed growth of almost 12%Q/Q in Q2, and the September level was still more than 4% higher than before the pandemic. Meanwhile, significant price increases saw the retail sales deflator rise to an elevated 3.4%Y/Y. Nevertheless, the value of retail sales still fell for the fourth month in the past five, dropping 0.2%M/M in September to be down a chunky 2.3%Q/Q in Q3.

Of course, part of the weakness last quarter reflects the increased opportunities to spend on consumer facing services as Covid-related restrictions eased. But a deterioration in consumer confidence might also have played a role amid rising prices and squeezed household budgets, as well as perhaps the recent jump in Covid cases. And the overnight release of October’s GfK consumer confidence survey showed the headline sentiment index falling for the third consecutive month and by a further 3pts to -17, the lowest level since February. Perhaps inevitably, there was a sizeable decline in households’ expectations for the economic outlook over the coming twelve months (down 10pts on the month), while their expectations for personal finances over the year ahead also dropped (-4pts) to the lowest since November. And so, there was a further decline in household intentions to make major purchases to the lowest level since April, suggesting that the outlook for retailers remains soft.

Still to come this morning, the preliminary October PMIs are also expected to flag persistently high price pressures against the backdrop of supply bottlenecks. And with firms also expected to report labour shortages, as well as softer demand, the output PMIs, for both manufacturing and services, are likely to have fallen somewhat at the start of the fourth quarter, albeit remaining above the key-50 expansion level. Indeed, the UK's composite PMI is expected to edge down to 54.0 in October, from 54.9 previously, marking the lowest level in eight months.

Euro area flash October PMIs likely to have softened amidst ongoing bottlenecks
In the euro area the focus today will be on the release of the flash PMIs for October, which are expected to reveal that ongoing and widespread supply bottlenecks weighed further on business sentiment, with the headline output PMIs likely to have fallen further. Nevertheless, not least given the ongoing recovery in services, the composite output indices for the member states are expected to remain comfortably above the key 50-mark, therefore signalling only a moderate loss of recovery momentum rather than contraction. Indeed, the headline euro area composite PMI is forecast to have fallen 1pt to 55.2 in October, the lowest level in six months.

Flash October PMIs also ahead in the US; Fed’s Powell to participate in panel discussion
While they play second fiddle to the long-running ISM surveys, today’s flash Markit PMIs readings for October will nonetheless be of interest during a day otherwise devoid of major US economic data (the Treasury will release its September spending and receipts figures, but as usual will doubtless be close to CBO estimates). Fed Chair Powell will speak on a panel discussing post-Covid monetary and fiscal stability challenges, while the flow of corporate earnings news slows today before moving into top gear next week.

Australia’s composite output PMI rises to a 4-month high of 52.2 in October as restrictions on activity begin to ease; pricing pressures increase markedly in the manufacturing sector
As far as economic data is concerned, the domestic focus in Australia today was the flash Markit PMIs for October. Encouragingly, with restrictions on activity having begun to ease in New South Wales, and Victoria beginning that process today, the composite output index jumped 6.2pts to 52.2 – the first expansionary reading since June. Predictably, most of the improvement owed to a sharp increase in sentiment in the services sector. Indeed, the headline services PMI – the business activity index – increased 6.5pts to four-month high of 52.0. The new orders index increased a similar 6.7pts to 52.2, but the employment index – already back in expansionary territory last month – nudged down 0.2pts to 51.5. As far as the pricing indicators were concerned, the input prices index increased 1.3pts to a three-month high of 60.4 but the output prices index was steady at 55.5 – the latter about 1pt below the record high recorded in June.

After rebounding sharply from a 14-month low in September, the headline manufacturing PMI increased 0.5pts to a very solid 57.3 in October, albeit flattered somewhat by the impact of supply bottlenecks on delivery times and prices. The output index increased 0.4pts to a clearly expansionary 53.2 – also a four-month high. More encouragingly, the new orders index increased 2.8pts to 55.2, while the new export orders index increased by an even larger 4.3pts to a five-month high of 53.9. Less positively, the employment index, which has remained resilient through the recent virus outbreak, fell 2pts to 52.5. The impact of supply chain bottlenecks was evident in the delivery times index, which edged down 0.1pts to just 24.0 – just 1.4pts above the pandemic low. Meanwhile, the inputs index increased 3.6pts to 82.1 and output prices index increased 3.7pts to 67.2 – in both cases the highest readings since this data was first collected in 2016.

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