Japan’s household spending slips back in July as Covid cases rise and real incomes fall
While Japan’s economic recovery in the second quarter was driven by private consumption, today’s monthly household expenditure survey suggested that spending fell back in July, falling 1.4%M/M to almost fully reverse the increase in June. The weakness was broad-based, with spending down on clothing by a notable 5.9%M/M, household appliances (-3.8%M/M), medical care (-3.2%M/M) and recreation (-2.5%M/M), perhaps reflecting a surge in Covid-19 cases and extremely subdued confidence. When excluding some of the more volatile items (i.e. housing, transport) core spending was down a somewhat more modest 1.1%M/M, although that left it almost 1½% below the Q2 average and still more than 10% below the pre-consumption tax hike peak in September 2019.

The weakness in spending will partly reflect households declining real disposable income, which fell 5%Y/Y in July. Admittedly, the latest labour earnings figures were broadly encouraging in nominal terms, with total wage growth moderating only slightly in July, by 0.2ppt to 1.8%Y/Y. And this slowdown was related to overtime and bonus payments, which were still up a solid 4.7%Y/Y and 2.8%Y/Y respectively. Indeed, regular wage growth rose 0.1ppt to 1.2%Y/Y, the second-fastest pace for 25 years (exceeded only by 0.1ppt in November 2018). Of course, given the increase in prices, real regular wage growth remained firmly in negative territory, at -1.6%Y/Y, the joint-steepest drop since May 2020.

German factory orders fall for sixth successive month at start of Q3, adding to evidence of slide into recession as energy shock takes its toll
Momentum in Germany’s manufacturing sector appears to have remained in reverse at the start of the third quarter, with new factory orders dropping for the sixth successive month and by 1.1%M/M, a touch more than had been expected. That left them down a whopping 13.6% from the post-pandemic peak, which occurred one year earlier, 1.4% below the Q2 average, and at the lowest level since September 2020. New factory orders were still, however, about 2% above the pre-pandemic level in February 2020.

Weakness in the latest month came from domestic orders, which dropped 4.5%M/M, and orders from the euro area, which dropped 6.4%M/M, perhaps adding to concerns that the region’s economy might be slipping into recession amid concerns about energy supply and falling real incomes. In contrast, orders from beyond the euro area rose 6.5%M/M. By type of good, the weakness was particularly pronounced in orders of consumer goods, down 16.9%M/M due not least to a drop of more than 23%M/M in orders of pharmaceuticals, which had seen double-digit growth the previous month. Orders of capital goods were little changed (-0.2%M/M) while those of goods were up 1.5%M/M.

Finally, real turnover in German manufacturing fell 1.8%M/M in July, tallying with survey evidence that suggests that tomorrow’s IP data will report a decline in factory output at the start of Q3 (consensus is for a drop in IP of about 0.6%M/M). As manufacturers continue to try to reduce their dependence on energy, in particular natural gas, yesterday’s decision by the government to retain two of its nuclear power stations on stand-by as a possible “emergency reserve” for energy over the winter seems welcome and has helped wholesale natural gas prices fall back somewhat this morning. But it is unlikely to be a game-changer for growth. Indeed, despite the weekend announcement by the government of plans for a €65bn (2% of GDP) package of new fiscal support to cushion the impact of high energy prices on households and business, we maintain our baseline forecast of German recession.

New PM Truss reportedly to freeze UK household energy bills via government-back loans, capping rise in inflation but adding to bills over subsequent years
Sterling has firmed this morning to around $1.16 on reports that new UK PM Liz Truss will tear up plans to hike household energy bills by 80% next month, instead seeking to freeze tariffs for two years and thus avoiding a massive new adverse shock to real disposable incomes. An announcement could come on Thursday. While detail remains sketchy, the proposal appears broadly in line with that of Scottish power, whereby the government would guarantee loans issued by energy-generators to fund the costs, which would be repaid by households over the subsequent decade or more. The costs could be close to £100bn (roughly 4% of GDP), with additional initiatives likely to be taken to subsidise bills of small businesses too.

The new measures could reduce the peak in CPI inflation by roughly 4ppts to about 10½%Y/Y as well as limiting the near-term contraction in GDP. While that might take some pressure off the BoE, with core inflation (6.2%Y/Y in July) the highest of all major industrialised economies and the labour market still historically tight, the BoE would seem highly likely to press ahead with an accelerated path of tightening over coming months in the absence of (an unlikely) marked appreciation of sterling. Indeed, yesterday afternoon hawkish external MPC member Catherine Mann called for the BoE to act “more forcefully now” suggesting she will vote a 75bps hike next week. And we expect the majority on the MPC to feel the same way.

Construction surveys to suggest falling output in sector in euro area and UK as higher rates and falling real incomes hit new housing demand
Looking ahead, this morning will bring the latest construction PMI surveys for August from the euro area, Germany, France, Italy and UK. These will likely imply a further contraction in activity in the sector, after the headline euro area and UK activity indices fell in July to the lowest since February 2021 at 45.7 and 48.9 respectively.

US services ISM expected to point to softer economic growth in Q3
In the US, today’s focus will be the services ISM for August, which is expected to signal a further slowing in economic momentum during the summer, albeit remaining comfortably in expansionary territory. Broadly in line with the consensus, our colleagues in Daiwa America expect the headline activity index to drop 1.7pts to 55.0, which would be the lowest level since May 2020. The activity and new orders components appear subject to downside risks, not least as payback for the surprising strength in July.