Japan retail sales and IP weaken in December, but still point to solid growth in Q4
While next week’s Japanese GDP data are likely to report a notable pickup in growth in the fourth quarter as the economy enjoyed a boost from the ending of the state of emergency restrictions at the start of October, today’s monthly releases flagged a weakening trend in economic activity towards the end of the year amid rising concerns about the latest pandemic wave. In particular, retail sales fell 1%M/M in December, as spending on food and fuel fell sharply, while sales of clothing and household goods also slipped back. But spending on motor vehicles rose sharply for the second successive month, perhaps reflecting an easing in supply bottlenecks. Of course, the drop in overall sales in December followed a cumulative increase of more than 5% since August. As such, sales rose up by 2%Q/Q in Q4, the largest quarterly increase since Q320. And with spending on services having also rebounded as the restrictions were relaxed, today’s release suggests that household consumption provided a sizeable contribution to GDP growth in Q4.

But the near-term spending outlook remains clouded by the spread of the omicron variant. This was flagged by today’s consumer confidence survey, which saw the headline sentiment indicator decline 2.4pts in January – the most since April 2020 – to a five-month low of 36.7. Unsurprisingly, the weakness was broad-based, with the largest decline (-4.8pts) in the index for employment expectations, also to a five-month low. But households were also seemingly less willing to spend on durable goods too, with the relevant index down more than 2pts to its lowest for a year.

Turning to the manufacturing sector, December’s industrial production numbers also declined slightly short of expectations, falling 1.0%M/M. This principally reflected a near-5%M/M drop in production of general machinery, with output of electronic parts and devices also down 3%M/M and electrical machinery down more than 2%M/M. But there were modest increases in production of ICT equipment and autos in December (albeit output in both sub-sectors remained almost 8% below the pre-pandemic level). And overall, the drop in IP in December followed growth of 7.0%M/M in November. So, over the fourth quarter as a whole, manufacturing output rose by 1%Q/Q, driven by a 20%Q/Q increase in the autos sector. Of course, this reversed only a fraction of the near-4%Q/Q decline in Q3, to leave manufacturing output still more than 2% lower than the pre-pandemic level. Nevertheless, the flash PMIs pointed to a further improvement in production at the start of the New Year. And while manufacturers are often too optimistic about their production projections, METI today suggested that they remained extremely upbeat, forecasting growth of 5.2%M/M in January and 2.2%M/M in February.

Looking ahead, tomorrow will bring an update on labour market conditions at the end of last year too. The unemployment rate is expected to have moved sideways at 2.8% in December, while the job-to-applicant ratio edged slightly higher to 1.15x. But it will be interesting to see whether the pickup up in activity triggered an increase in the number of people in employment, which in November fell to a post-pandemic low. Tomorrow will also bring the final manufacturing PMI survey for January, alongside new car registrations numbers for the same month, which both likely to point to a pickup at the start of the year. Meanwhile, the final services PMIs (Thursday) are expected to confirm a marked deterioration in conditions since the New Year as new pandemic wave and restrictions limited activity in consumer-facing services.

China’s PMIs signal continued weakness into 2022
Not least due to the disruption caused by lockdowns and adjustments in real estate, China’s PMIs for January, released on the weekend, suggested that weakness in both manufacturing and non-manufacturing sectors has, perhaps predictably, extended into 2022. The official manufacturing PMI fell 0.2pt from December’s 5-month high back to 50.1, with the output index down a larger 0.5pt to a three-month low of 50.9 and the new orders index down to 49.3, also the lowest since September. And the only aggregate sub-indices to increase within the sector were those for input prices (56.4) and output prices (50.9), which rebounded from sub-50 readings in December. Small manufacturers signalled a faster pace of contraction (46.0) while large- (51.6) and medium-sized (50.5) firms reported ongoing sluggish expansion. The non-manufacturing PMI signalled the softest growth in the sector since August, falling 1.6pts to 51.1. New orders were also the weakest in five months (down 0.6pt to a very contractionary 47.8). And, as in the factory sector, non-manufacturing firms reported increased price pressures for inputs (52.1) and sales (51.0). As ever, the Chinese data for this time of year need to be treated with caution due to the impact of the Lunar New Year. However, it’s hard to imagine that underlying momentum is any firmer than these data suggest, and further monetary and fiscal easing seems likely in due course.

Euro area Q4 GDP and January inflation estimates set to confirm a slowdown
Today will bring the first estimate of euro area Q4 GDP. Given the data from the member states released last week, we maintain our expectation that euro area economic activity slowed sharply at the end of last year, to 0.3%Q/Q, the softest pace for a year but nevertheless enough to return output to its pre-pandemic level. Despite the slowing economic recovery, the latest labour market data (tomorrow) are expected to report a further decline in euro area unemployment in December. The euro area’s flash January inflation estimate is due on Wednesday and expected to report a marked drop at the start of the year in part due to the impact of past German tax changes. We expect the headline CPI rate to have fallen 0.8ppt to 4.1%Y/Y, with the core measure down 0.7ppt to 1.9%Y/Y – preliminary estimates from Germany and Spain (today) and France (Tuesday) will offer greater insight. The end of the week will bring euro area retail sales numbers for December, as well as German factory orders and French industrial production data (Friday), January new car registrations numbers from the larger member states and the final January manufacturing, services and construction PMIs.

ECB set to leave economic assessment and policy unchanged
The ECB’s latest policy-setting meeting will conclude on Thursday too. But in marked contrast to the previous meeting in December, the announcements look set to be uneventful. Certainly, there appears to be no pressing need to amend its overall economic assessment, with slower growth at the turn of the year to be followed by above-potential rates in Q2 and Q3 as the latest coronavirus wave fades and supply bottlenecks ease. Moreover, while the near-term profile of inflation might well exceed the path set out by the ECB in Q1 and Q2 due to higher prices of energy, food and other goods, the annual CPI rate still likely peaked in December. And as projected by the ECB, inflation should be close to (or below) the 2.0%Y/Y target by year-end. So the Governing Council will probably also continue to see the risks to the economic outlook as broadly balanced, while acknowledging the very large degree of uncertainty.

As such, we expect no change to the ECB’s policy outlook, with just the confirmation that net PEPP purchases will conclude in March and that net APP purchases will double to €40bn per month in Q2, then slow to €30bn in Q3 and to €20bn per month from October. In her press conference, President Lagarde will likely reiterate that economic conditions in the euro area differ markedly from those in the US, and that the preconditions for rate hikes set out in the ECB’s forward guidance are unlikely to be met before the end of the year. She will also likely repeat that the Governing Council stands ready to adjust policy if and when the inflation outlook differs significantly from the path currently set out in the ECB’s projections. But she should echo comments made last week by ECB Chief Economist Lane that the Bank’s asset purchases would be reduced further to zero before any increase in interest rates.

BoE to raise Bank Rate to 0.5% and confirm the start of quantitative tightening
Unlike the ECB, the BoE’s MPC meeting looks firmly set to bring a change in policy on Thursday. Bank Rate is highly likely to be hiked by 25bps to 0.50%. And assuming that threshold for Bank Rate is reached, the BoE’s guidance means that policymakers should also agree to start quantitative tightening, ceasing reinvestments of the proceeds of maturing bonds from its holdings starting with the redemption of £25bn of Gilts in March. With a rate hike this time around fully expected and priced by the markets, the policy decisions on their own should have minimal impact on Gilts. However, if the experience of previous meetings is anything to go by, the BoE’s assessment of the economic outlook in the Monetary Policy Report and Governor Bailey’s comments in the post-meeting press conference could yet generate some market volatility.

US ISM surveys and employment report set to flag hit from omicron in January
After a quiet start to the week, it will be another busy week for US releases, with particular focus on the impact of the latest pandemic wave on the ISM surveys and employment reports. Following the decline in the flash PMIs, the manufacturing ISM (due tomorrow) is expected to have slipped back in January while remaining at a still healthy level of 58 suggestive of ongoing recovery. The influence of omicron will of course be felt more acutely in the services sector, with the respective ISM survey (Thursday) likely to report a more sizeable drop in the headline activity index, albeit leaving it still an a historically elevated level. The latest pandemic wave also probably held back hiring in January, with Friday’s employment report likely to report a notably softer increase in payrolls than the average job growth of 565k in 2021. Indeed, Daiwa America’s Mike Moran is forecasting an increase of 200k in January, pretty much unchanged from December but above the BBG consensus of 150k, with the unemployment rate unchanged at 3.9%. This report will contain benchmark revisions to the payroll figures based on a universal count as of March 2021 – a preliminary estimate published in August showed that payrolls in the benchmark month were 161,000 lighter than previously believed. And as with every January report, the household survey will incorporate new population controls without revising past results and so figures – including for unemployment and labour force participation – for January will not be strictly comparable with previous results. Other releases this week include the ADP employment report (Wednesday) and durable goods data (Thursday). Meanwhile, the Fed’s Daly will speak at an event this afternoon, while Fed governor nominees Sarah Bloom Rashin, Lisa Cook and Philip Jefferson will appear at a nomination hearing before the Senate on Thursday.