BoJ and ECB policy meetings in focus

Chris Scicluna
Emily Nicol

S&P500 and real bond yields fall amidst growth and inflation concerns; Asian bourses mostly weaker while Aussie short bond sell-off gathers pace; all eyes now on the ECB
Despite trading modestly in the black for most of the session, the S&P500 fell away in the last hour of trade, eventually closing with a 0.5% loss. Growth concerns seemed evident in a further decline in real bond yields, with the nominal 10Y UST yield closing down 5bps at 1.55% but the 10Y breakeven falling just 1bp from the previous day’s 15-year high to 2.68%. Nominal yields continued to rise at the front of the UST curve, however, with the 2Y yield hitting a new high of 0.51%. The pricing of a more hawkish outlook for global monetary policy continued in Canada with the BoC discontinuing its QE programme and bringing forward its forecast of the first hike in its policy rate to the “middle quarters” of next year.

Since the close, US equity futures have firmed a couple of tenths while UST yields have nudged higher. Against that background, most of the major Asian bourses have lost ground today. In Japan, despite news of a larger than expected rebound in retail sales, the TOPIX declined 0.7%. Unlike the BoC, and ahead of the ECB’s policy announcements later today, the BoJ provided the market with no surprises, with all aspects of its policy left unchanged and the updated forecasts in the Outlook Report containing only small and predictable revisions. While the Bank maintained a constructive medium-term outlook, JGB yields slipped modestly today given the risk-off sentiment in markets. Markets are also slightly weaker in mainland China, Hong Kong and South Korea despite a more positive Q3 earnings report from Samsung.

In the Antipodes, it was another hectic day in Australia’s bond market, with the sell-off at the short end gathering considerable pace. Following yesterday’s sharp lift in short-end yields in response to the unexpected rise in core inflation, investors had clearly expected the RBA to step in today to defend its 0.1% target for the April 2024 bond. However, the RBA refrained from making purchases, thus raising questions about whether yesterday’s inflation news had altered the Bank’s commitment to the target and its dovish monetary policy stance more generally. As a result, the yield on that bond has jumped a whopping 32bps to 0.52% today – far above where the RBA intervened earlier this week – and the yield on the 3Y bond has increased 22bps to 1.16%. The selling at the short-end has also weighed on the long end of the curve too, with the 10Y yield rising 5bps to 1.87% despite the rally in the comparable UST. Meanwhile, the ASX200 has declined 0.3% today, led by weakness in energy-related stocks.

BoJ leaves policy settings unchanged; makes predictable revisions to forecasts in the Outlook Report, which maintains a constructive medium-term outlook for the economy
As widely expected, this month the BoJ’s Board once again left all dimensions of its policy unchanged, including leaving its short-term policy rate at -0.1% and the 10Y JGB yield target at around 0%. As usual, Kataoka was the only dissenter to the decision, maintaining his call for short- and long-term interest rates to be lowered. In addition, the upper limit for the Bank’s purchases of ETFs (about ¥12trn) and J-REITS (about ¥180bn) was unchanged, as was the Bank’s commitment to purchase, until the end of March, up to ¥20bn of CP and corporate bonds in total. Also untouched was the Bank’s commitment to purchase an unlimited amount of JGBs as required to hit its 10Y yield target. As usual, the Bank’s forward guidance continues to indicate that it expects short- and long-term policy rates to remain at current levels or lower. While experience indicates a marked reluctance to lower interest rates further, the Board continues to assert that it will not hesitate to take additional easing measures if deemed necessary.

Predictably, attention today was principally on the BoJ’s latest quarterly Outlook Report. Revisions to Board members’ projections regarding activity provided no surprises. With the economy having recently performed worse than expected previously, due to the impact on services consumption of summer surge in virus cases and the impact of supply chain bottlenecks on exports and production, the median Board member now expects GDP to grow 3.4% in FY21 – 0.4ppts less than forecast in July. Some of that reduced growth is expected to be recouped the following year, with the median forecast for FY22 lifted by 0.2ppts to 2.9%Y/Y. As was the case in July, the median forecast for FY23 is that growth will slow to 1.3%Y/Y. The Bank’s medium-term outlook continues to hinge on the reasonable assumption that the negative impacts of coronavirus will wane mainly thanks to increasing rates of vaccination. The economy is expected to be further supported by growth in external demand, accommodative financial conditions and the government’s fiscal measures. Later in the period, while no longer supported by pent-up demand from home and abroad, the Bank expects that an intensifying ‘virtuous circle’ from income to spending will allow the economy to continue to grow at an above-trend pace. The economy’s potential growth rate – most recently estimated by the BoJ to be close to zero – is forecast to increase to productivity gains from digitalization and the recovery in business fixed investment.

The BoJ’s updated forecasts for inflation are the first to be compiled using the new 2020 CPI base year. As a result, in line with the downward revisions made to the CPI back in August, the BoJ’s forecasts depict a significantly weaker near-term inflation outlook due mostly to the greater weight that the revised CPI gave to the huge fall in mobile calling charges seen back in April. The median Board member now forecasts no change in the core CPI (which excludes only fresh food) in FY21, compared with the 0.6%Y/Y increase that was forecast previously. Looking further ahead, while the Bank notes a pick-up in inflation expectations, the median Board members’ forecast of core inflation in FY22 and FY23 was unchanged from that in July at 0.9%Y/Y and 1.0%Y/Y respectively. However, for FY23, the most optimistic Board member now sees inflation at 1.3%Y/Y while the most pessimistic member sees inflation at 0.8% – in both cases 0.1ppts higher than the comparable forecasts in July.

Appropriately, the Bank acknowledges that the outlook remains subject to elevated risks. In particular, the Bank highlights uncertainty over whether the resumption of economic activity can progress smoothly while still protecting public health. In addition, the Bank also draws attention to the risk that the effects of supply-side constraints could be amplified or prolonged compared to that assumed in the baseline forecast. Not surprisingly, for the time being it considers that the overall balance of risks to activity remains skewed to the downside. However, from about the middle of the projection period, the Bank views the risks to activity as generally balanced. Fittingly, given its past undue optimism, the BoJ considers that the risks to inflation are skewed to the downside throughout the forecast period.

Japanese retail sales stage partial rebound in September
Ahead of tomorrow’s larger dump of monthly indicators, the only economic report in Japan today concerned retail sales. With virus numbers receding sharply but state of emergency restrictions in place in many prefectures until the end of the month, spending recovered only 2.7%M/M in September – albeit almost double the consensus estimate – following an unrevised 4.0%M/M decline in August. Spending was down 0.6%Y/Y, compared with the 3.2%Y/Y decline reported in August, and was fractionally below its pre-pandemic level. The rebound in September was driven by a 13.7%M/M recovery in spending on apparel and accessories, which had declined sharply in each of the previous two months. While spending on general merchandise and household machines increased 5.8%M/M and 8.6%M/M respectively, production cuts in the auto sector led to a 10.7%M/M decline in spending on motor vehicles.

Today’s figures indicate that retail spending increased 1.1%Q/Q in Q3 despite the summer virus outbreak, However, as always, we caution that a more complete indication of overall consumer spending, as measured in the national accounts, will be provided by next month’s release of the BoJ’s Consumption Activity Index and by the even more accurate Cabinet Office Synthetic Consumption Index. For the first two months of Q3, the latter two indicators presently indicate a moderate pullback in private consumption spending in Q3 following an unexpected lift in Q2.

ECB Governing Council meeting headlines a busy day in the euro area: after big upside surprise to Spanish inflation, Lagarde likely to keep powder dry ahead of December’s key policy decisions
Like the BoJ, the ECB is bound to leave policy unchanged when its Governing Council meeting concludes today. But with the following meeting in December set to be pivotal in determining the pace of asset purchases in early 2022 and the nature of asset purchases further ahead, President Lagarde’s press conference will be closely watched for changes in assessment of the inflation outlook. Certainly, as flagged again already this morning by Spain’s flash CPI data (see below), the ECB’s near-term inflation forecast, published just last month, was too low. And so, the hawks on the Governing Council, whose concerns about upside risks were already aired at the September meeting, are bound to feel emboldened. However, the majority of the Governing Council will likely still expect inflation to fall back over the course of 2022 to below 2.0%Y/Y by year-end. And they will also be concerned about the downside risks to demand posed by the current shock to energy prices.

Of course, financial conditions are also a key determinant of current ECB policy, particularly the pace of net asset purchases. But while nominal bond yields have recently jumped, that reflects higher financial market inflation expectations while real yields have fallen to new lows. So, we don’t expect Lagarde to signal any concern about recent bond market developments. By the same token, however, we don’t expect Lagarde to mimic the recent hawkishness of the BoE’s Governor Bailey and certain other central bankers. Instead, we expect her to keep her powder dry for the December meeting. Indeed, with no updated projections to be published at this meeting, Lagarde might continue to judge the risks to the economic outlook as broadly balanced albeit noting the significant uncertainty posed by the ongoing supply-side shocks.

Spanish inflation surprises significantly to the upside
Data-wise, ahead of the equivalent figures from Germany, this morning’s flash Spanish estimates of inflation in October came in well above expectations. On the EU-harmonised HICP measure, Spanish inflation jumped 1.5ppts to a euro-era high of 5.5%Y/Y, some 0.9ppts above the Bloomberg consensus. Spain’s statistical agency provided little detail, apart from making it clear that the increase was driven by electricity prices and to a lesser extent by fuels and oil prices for personal vehicles and gas, whose impact was exaggerated by base effects. Indeed, on the national measure, while the headline rate also leapt to 5.5%Y/Y, the rise in core inflation was much more muted, up 0.4ppt to 1.4%Y/Y, marking the largest difference between the headline and core rates since the series began in 1986. The German numbers due later today might also now be expected to exceed the BBG consensus (a rise of 0.4ppt to 4.5%Y/Y). However, it is worth emphasising that Spain’s inflation data are typically most affected by fluctuations in energy prices, and the impacts elsewhere are unlikely to be quite so marked.

Beyond the inflation data, among today’s other data, the Commission’s comprehensive business and consumer confidence surveys are expected to indicate a further moderation in recovery momentum at the start of Q4, with the headline ESI forecast to fall to a five-month low. The survey’s price expectations indices will also no doubt be closely watched.

UK car production the weakest in any September since 1982 as supply constraints hinder recovery
Today’s SMMT car production figures were again disappointing in September, with just 67k units leaving factory gates, a pickup in output seen over recent months but nevertheless the worst performing September since 1982. So output was still down 41.5%Y/Y despite the pandemic-induced low base a year earlier – indeed, production was down by more than half compared with the average output in the decade leading up to the pandemic. Supply challenges relating to the pandemic and global semiconductor shortage remain the factor behind the weak production trend, with a separate SMMT survey today suggesting more than 80% of auto manufacturers having been negatively impacted due to reduced orders, cost increases and logistical disruptions. And more than half do not expect supply constraints to improve until Q322, with one third having reduced operating hours to cope with these persistent challenges.

Q3 GDP figures and corporate earnings the focus in the US today
Today’s US economic diary is highlighted by the first release of the national accounts for Q3. At the beginning of the week, Daiwa America’s Mike Moran estimated that GDP grew 2.5%AR – slightly below the consensus estimate in Bloomberg’s survey. If anything, following yesterday’s news of an unexpected sharp widening of the merchandise trade deficit in September, the balance of risks to that estimate appear to lie to the downside, with net exports perhaps subtracting 1ppts from growth. A marked deceleration in consumer spending will likely remain the standout in the report, probably increasing less than 1%AR versus almost 12%AR in the first half of the year. Residential construction and business investment in new equipment will also likely prove two soft spots. As a result, government spending and a smaller inventory drawdown are likely to account for most of the advance in GDP. Today will also bring the release of pending home sales data for September – of interest following the sharp 8.1%M/M uplift reported in August – and the Kansas Fed’s manufacturing survey for October. Meanwhile, another busy day of corporate reporting also lies ahead, with today’s line-up including the likes of Apple, Amazon, Caterpillar, Merck and Mastercard.

Aussie export prices rise a further 6.2%Q/Q to new record high in Q3
Following on from yesterday’s CPI report, today the ABS released its International Trade Prices Indexes report for Q3. Driven by particularly sharp increases for coal and gas, the export price index surged by a further 6.2%Q/Q to a new record high. As a result, prices were up an enormous 41.0%Y/Y, with coal and gas up more than 82%Y/Y and 96%Y/Y respectively and metal ores up more than 36%Y/Y. Import prices increased 5.4%Q/Q, lifting annual growth to a relatively subdued 6.4%Y/Y. This result that implies another lift in Australia’s terms of trade, providing support to national income during a lockdown-impacted the quarter. Higher prices for imported petroleum, fertilisers and iron and steel were especially notable in Q3, with prices for petroleum now up 57%Y/Y.

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