UK GDP declines for second month in April

Chris Scicluna

Stocks plunge as yields keep rising after US CPI; BoJ steps up bond-buying to defend YCC target
A torrid start to a busy week for central bank announcements and top-tier economic news, with risk appetite still in retreat following Friday’s substantive upside surprise to US CPI inflation. Japan’s Topix fell 2.2% with the Hang Seng down more than 3%. European stock markets down 1-2%. And US stock futures down 2%-plus. With new uncertainty regarding how far the FOMC will raise rates and signal more tightening on Wednesday, and the Fed set to start actively reducing its portfolio this week, USTs are again weaker across the board. 2Y yields are up another 15bps to 3.21%, now just a couple of bps shy of 10Y yields. Futures are now pricing a Fed Funds Rate target range between 3.25-3.50% for year-end and a terminal rate 50bps higher than that. And ahead of Friday’s BoJ policy announcement and after last week’s special meeting among Japanese officials on forex market developments, the BoJ stepped in to buy more JGBs as the 10Y yield rose above the top of the 0.25% YCC ceiling for the first time in six years, helping the yen firm back through ¥135/$ after hitting a new 24-year low near ¥135.2 earlier in the day

BTPs still in the firing line after the ECB, OATs underperform on fears Macron will do too; Gilts follow the trend despite soft UK GDP
In Europe’s bond markets, with plenty of commentary from the Governing Council to come this week, euro area govvies are weaker too, with BTPs being whacked particularly at the short end of the curve (2Y yields up another 18bps to 1.83%, now roughly 70bps above their level ahead of last week’s ECB announcements, but 10Y yields up to an 8-year high about 3.80%). OATs are also underperforming slightly after the first round of France’s legislative elections left it touch-and-go whether Macron’s group and allies will retain their national assembly majority against the resurgent left-wing bloc. And Gilts are weaker (2Y yields up almost 8bps to 2.10%) despite a downside surprise in the latest UK GDP data, which reported a second successive monthly drop in economic output and thus will have further complicated the BoE’s policy announcement on Thursday.

Will the Fed dare hike more than 50bps and the BoE dare to hike more than 25bps? And will the BoJ remain passive in the face of the weak yen?
After last week’s hawkishness from the ECB, a busy week for the major central banks brings announcements from the Fed (Wednesday), BoE (Thursday) and BoJ (Friday):

  • Until last week’s CPI data, the Fed had seemed almost certain this week to raise the FFR target range by 50bps to 1.25-1.50%, reaffirm that a further 50bps hike was on its way in July, but leave open the door to a smaller hike in September. After that painful upside surprise, however, a 75bps hike this week could be up for discussion, with a hike of 50bps in September likely to be the minimum expected. As the FOMC’s updated macroeconomic projections and dot-plots might have been finalised ahead of the release of those inflation data, they might need to be treated with some caution. However, with officials having already indicated that they wish to move rates “expeditiously” to neutral, a target range for the federal funds rate of 2.25-2.50% by year-end should be the minimum of what to expect. If they had the opportunity to consider last week’s data before finalizing their views, then a restrictive stance might be expected. However, the Fed will likely still take an upbeat view of the outlook for the unemployment rate (currently forecast at 3.5% at year-end), expecting the impact of tightening be felt via lower vacancies instead. And while the projection for the overall PCE rate at year-end (4.3%) is bound to be revised up whatever, the core PCE rate (4.1%) might even be revised down.
  • At the BoE’sMay meeting, “most” members of the MPC thought “some degree of further tightening… may still be appropriate in the coming months”. But the BoE’s projections suggested the terminal interest rate for the cycle would be below the level priced into markets. Since then, the UK government has made a big U-turn on fiscal policy, providing extra support to households to cope with higher energy prices. So, while today’s GDP data (see below) will lead the MPC to take a dimmer view of GDP in the current quarter, the BoE staff will now expect GDP to be somewhat stronger than it previously feared. At the same time, while oil prices are higher and the ONS has yet to provide its opinion, the subsidies could well reduce the peak in inflation in October to below the 10%Y/Y level that the BoE previously anticipated. Looked in the round, the majority (and perhaps all) of the MPC members are likely to see the case for a further rate hike on Thursday. But all the more so in light of the weakness of today’s GDP data, we think it will vote for an increase in Bank Rate of just 25bps to 1.25%. But a hike of 50bps can’t be ruled out.
  • While Japanese GDP this quarter is improved from Q1 and headline inflation has recently crept just above its 2% target, unlike the other major central banks, for the BoJ the inflation outlook doesn’t merit tightening. Hence why it continues to fight against the bond market, today committing to buy an extra ¥500bn of JGBs of 5-10Y maturity after the 10Y yield popped above 0.25% for the first time in more than six years. And hence why there are no expectations of a sudden shift in BoJ monetary policy this week. But the weak yen remains an irritation. And after last Friday’s special meeting between the BoJ, MoF and FSA saw the officials state the importance of a stable exchange rate in line with fundamentals, and repeat that rapid fluctuations are now desirable, Kuroda is bound to be pressed on his view up to now that a weaker yen was at the margin beneficial for Japan. Of course, even if he did signal his unease at recent forex market developments, any active intervention (which would far more likely be unilateral than multilateral) that was not backed up by adjustment to BoJ monetary policy would ultimately be likely to have a negligible lasting impact.

UK GDP declines for second month in April as all sectors contract
Contrasting the signals from surveys of ongoing growth, and also contrary to the consensus expectation, UK GDP fell for a second successive month in April. In particular, total economic output contracted 0.3%M/M, the most in fifteen months, to be 0.4% below the Q1 average albeit still 0.9% above the pre-pandemic level in February 2020. Unusually, activity in all main sectors declined. Services output fell 0.3%M/M to be a similar amount below the Q1 average as a marked drop in healthcare (-7.6%M/M), due to a steep fall in pandemic-related test-and-trace activity, more than wiped out the (likely temporary) boost from wholesale and retail trade (up 2.7%M/M). Restrained by ongoing supply-chain challenges, manufacturing output dropped for a third successive month and 1.0%M/M to be 1.3% below the Q1 average. And construction fell for the first time since October, declining 0.4%M/M from March’s series high, but still 0.8% above the Q1 average. With data due Friday set to show that retail activity was much weaker in May, healthcare spending likely to decline further too as the impact of the spring booster fades, and the extra bank holiday to hit output in June, the data strongly point to a drop in GDP over Q2 as a whole – a factor that might lead the BoE to raise Bank Rate by just 25bps on Thursday.

US retail sales and Chinese economic activity top a busy week for economic data:
In the US, retail sales figures for May on Wednesday are expected to be softer than in April, restrained not least by a drop in new vehicle sales. However, while they are likely to erode the volume of sales of many items, sharply higher prices will boost the value of sales at gasoline services stations. Our colleagues at Daiwa America expect total retail sales to be unchanged on the month but sales ex autos to be up 1.0%M/M. Among other US data due, PPI inflation figures will suggest continued elevated pipeline price pressures in May, similarly boosted by prices of energy and food (forecast 0.8%M/M total, 0.5% excluding food and energy). Import prices data (Wednesday) will also be firm. Housing starts figures for May will likely drop for the fourth month in the past five with Daiwa America forecasting a decline of 5.8%M/M, much larger than the consensus. However, industrial production data (Friday) are expected to report a fifth successive monthly rise, albeit much softer than the growth of 1.0%M/M in April.

We expect the UK’s latest labour market report (tomorrow) to push the unemployment rate a fraction down to 3.6%, which would be the lowest since 1974. That will in part reflect the continued high level of economic inactivity, as the number of people in employment will remain roughly 500k down from the pre-pandemic level. And due in part to base effects, we expect growth in nominal average weekly earnings to slow slightly from 4.2%3M/Y (excluding bonuses) and 7.0%3M/Y (including bonuses) and thus be negative in real terms. Friday’s retail sales data are also likely to be weaker, with the 1.4%M/M rise in sales in April likely to be in part reversed (forecast -0.7%M/M).

Final inflation figures for May – from Germany (tomorrow), France (Wednesday), Italy (Thursday) and euro area (Friday) – are expected to confirm the preliminary estimates, for which the euro area HICP rate rose 0.7ppt to 8.1%Y/Y with the core rate up 0.3ppt to 3.8%Y/Y. Sentiment-wise, the ZEW investor survey for June (tomorrow) is likely to report a modest pickup in investor confidence, albeit with expectations still in recession territory. Production in Germany (1.3%M/M, excluding construction), Italy (1.6%M/M) and Spain (2.1%M/M) might suggest positive growth in euro area IP in April (Wednesday). But France was broadly flat (-0.1%M/M), and an extreme drop in Ireland (-9.6%M/M) points to a second successive drop for the euro area as a whole. As suggested by recent negotiated wage data, euro area labour cost figures for Q1 (Thursday) will report a pickup from 1.9%Y/Y in Q4. And despite positive growth in France (1.2%M/M), euro area construction output figures for April (Friday) will likely post a first decline since December weighed not least by the decline of 2.1%M/M in Germany as supply-chain pressures take their toll.

In Japan, the dataflow includes final IP data for April (tomorrow), which are likely to confirm a drop of more than 1.0%M/M in output due to ongoing supply-chain constraints. Wednesday’s machine orders figures are also expected to be soft, with payback for the strong jump of more than 7%M/M in March. But tertiary activity figures the same day will likely report growth of more than ½%M/M supported by ongoing normalisation of consumer-facing services activity. Goods trade data for May the following day are expected to post a vigorous rebound in import growth, and a softer acceleration in exports, reflecting the easing of pandemic restrictions in China. The trade deficit could well trouble January’s seven-year high of ¥2.2trn.

In China, Wednesday brings the May monthly activity data, with IP, investment in real estate and (especially) retail sales are set to remain firmly below levels last year – albeit with the rates of decline not quite as severe as in April – as pandemic restrictions persisted. IP is expected to be down about 1.0%Y/Y with retail sales down about 7%Y/Y. The jobless rate is expected to remain steady, albeit 1ppt above the level at the end of last year. A further modest cut by the PBoC in the 1Y medium-term lending rate from the current 2.85% can’t be ruled out.

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