UK’s 3Q GDP growth contracts, recession likely in 4Q

• GBP: UK GDP contracts by 0.2% QQ in 3Q 22 from a gain of 0.2% QQ in 2Q 22, but overshoots consensus expectation of a contraction of 0.5% QQ. This is the first quarterly drop since 1Q 21. Most of the decline is attributed to the additional bank holiday provided for the Queen’s funeral as most businesses were closed. The retail and professional sectors were most impacted. The consumer part of the economy continues to remain very weak, as households are hit by higher energy bills and inflated product costs. This caused real household expenditure to deteriorate by 0.5% QQ in 3Q 22. Monthly GDP growth also showed a contraction of 0.6% MM in September, a bit weaker than the consensus estimate of a fall by 0.4% MM. Citi Research think that the UK is now likely to enter recession in Q4, with output expected to fall by 0.1% then (versus 0.3% for the Bank) followed by a sharper contraction through 2023. UK weakness is for now concentrated among non traded sectors of the economy, reflecting the impact of the terms of trade shock. However, one element of these data that is particularly notable is that rates of sectoral reconfiguration have now fallen back to their pre pandemic norm. This is crucial. In recent months the UK economy has been beset by severe reallocation issues within both the labour market and amongst capital. With reallocation rates now falling, Citi Research think this creates scope for a margin of excess demand to now begin to emerge as the economy continues to slow. China finally eases quarantine rules despite surging local infections. 

• CNY: According to a statement released by the National Health Commission, China is reducing the quarantine for travelers and close contacts of infected people from “7 days in a hotel plus 3 days home quarantine” to “5+3”. The circuit breaker mechanism for international flight arrivals will also be scrapped. Furthermore, only one pre departure PCR test, instead of two, will be required for travelers attempting to enter China. These new changes were a part of the 20 new pandemic management measures discussed by the Politburo Standing Committee meeting held on Nov 10. The statement from the meeting highlighted improving medical research and vaccinations. It also criticized overzealous implementation at the local level. The rumors that started the rally since the beginning of November are turning out to be correct to a large extent. Meanwhile, daily Covid infections exceeded 10,000 for the first time since April, with Beijing’s number of cases at the highest level in more than a year. Further extension of re opening measures may still have to wait until the current wave passes, possibly in the spring.

Week Ahead - key data / events

• USD: US PPI Demand MoM Citi: 0.5%, median: 0.5%, prior: 0.4%; PPI YoY Citi: 8.3%, median: 8.4%, prior: 8.5%; PPI ex Food, Energy MoM Citi: 0.4%, median: 0.4%, prior: 0.3%; PPI ex Food, Energy YoY Citi: 7.3%, median: 7.2%, prior: 7.2%; PPI ex Food, Energy, Trade Services MoM Citi: 0.4%, median: 0.3%, prior: 0.4%; PPI ex Food, Energy Trade Services YoY Citi: 5.6%, median: NA, prior: 5.6% Citi Research expect details of PPI data in October and over the coming months will reinforce the themes in CPI and PCE inflation, namely that goods prices are slowing but there is greater upside risk to inflation from certain services prices. Citi Research expect a 0.5%MoM increase in total PPI final demand, with a solid 0.4% increase in core PPI that excludes food, energy, and trade services. Some idiosyncratic weakness in a 0.4% increase in core PPI however could obscure some continued underlying strength in inflation. While goods prices should remain on the softer side, there is likely also to be a substantial trade drag on PPI from a decline in portfolio management fees. While this will also weigh on PCE inflation in October, it is related to renewed declines in equity prices and not reflective of underlying inflationary pressures easing. On the other hand, there are significant upside risks to other services prices in October, such as medical services prices . Citi Research will be watching these prices in particular over the coming months as some could reset in a new fiscal year to account for increased costs, particularly labor costs. This is one important dynamic that Citi Research expect to contribute to PCE inflation moderating much slower than CPI over the next year.

• USD: Manufacturing Production Citi: 0.4%, median: 0.2% prior: 0.4%, Capacity Utilization Citi: 80.3%, median: 80.4%, prior: 80.3% Industrial production should rise a modest 0.1%MoM in October, but with a stronger 0.4%MoM increase in manufacturing production . Weaker utilities production in total IP would be a result of relatively more mild temperatures during the month of October. For the largest subset of manufacturing however, this would be another solid increase similar to September, in line with strength in manufacturing employment in October and a pick up in hours worked. The manufacturing sector does face downside risks from weaker goods demand globally and a strong US dollar weighing on export demand. However, real production as measured in the industrial production report has remained solid with no substantial weakening just yet, possibly as softer demand allows production to pick up after many months of constrained supply.

• USD: Retail Sales Citi: 1.4%, median: 0.9%, prior: 0.0%; Retail Sales ex Auto Citi: 0.5%, median: 0.6%, prior: 0.1%; Retail Sales ex Auto, Gas Citi: 0.2%, median: 0.2%, prior: 0.3%; Retail Sales Control Group Citi: 0.1%, median: 0.3%, prior: 0.4% Citi Research expect a strong increase in topline retail sales of 1.4%MoM in October. The strength is  highly concentrated in the motor vehicles category as unit sales for new autos jumped by over 11%MoM in October. There could be some more upside from autos in the near term as supply chain issues have been easing. Gasoline sales are also contributing a significant boost this month as gasoline prices increased on average in October. Citi Research expect a solid 0.5%MoM increase in restaurant sales. With strength concentrated in autos and gas, Citi Research expect a modest 0.1%MoM increase in control group sales for October as categories such as apparel, electronics and general merchandise are likely to be a drag this month.

• USD: Housing Starts Citi: 1400k, median: 1416k, prior: 1439k; Housing Starts MoM Citi: 2.7%, median: 1.6%, prior: 8.1%; Building Permits Citi: 1510k, median: 1520k, prior: 1564k; Building Permits MoM Citi: 2.3%, median: 2.8%, prior: 1.4% Citi Research expect the pace of housing starts and housing permit issuance to continue to slow in October. Broadly speaking, housing activity has certainly been slowing as higher mortgage rates dampen demand for housing. This should be most acute for builders higher mortgage rates limit the price that prospective buyers will be able to purchase a home at, and with inflationary pressures on inputs not abating, builders have less margin potential on newly constructed homes. This should drag starts and certainly permits, which are a more forward looking measure of housing demand and builder willingness to supply more homes . Multifamily starts and permits are a significant source of uncertainty though these tend to be less interest rate sensitive and volatile in general and could skew the headline print in either direction.

• USD: Existing Home Sales Citi: 4.45m, median: 4.38m, prior: 4.71m; Existing Home Sales MoM Citi: 5.5%, median: 7.0%, prior: 1.5% Citi Research expect the pace of continuing home sales to continue to decline in October. Higher mortgage rates have very clearly contributed to slowing home sales, which in turn is potentially being compounded by supply. While higher mortgage rates will continue to dampen home demand, their marginal impact should be lower now compared to the first half of the year, as most interest rate sensitive buyers should have already left the pool of potential home buyers when mortgage rates first legged higher.

• AUD: Australia October Labour Force Survey Citi employment forecast; 10k, Previous, 0.9k ; Citi unemployment rate forecast; 3.5%, Previous; 3.5%; Citi participation rate forecast; 66.6%, Previous; 66.6% The labour market remains tight, however, there are early signs that it has started to loosen from its extremely tight levels earlier in the  year.  Sentiment indicators from businesses suggest labour hiring will continue over the coming months, but at a slower pace than what businesses had previously expected. Indeed, Citi Research’s view is that the unemployment rate will likely start rising in 20 23, up from 3.5% to 4.3%. However, there are risks that it could begin to do so little earlier.

• AUD: Australia Q3 Wage Price Index Citi forecast; 1.1%, Previous; 0.7% Citi Research’s estimate of wages growth in Q3 is above consensus, and there are some downside risks to this forecast. That said, it’s unlikely to meaningfully shift Citi Research’s view on monetary policy if WPI is lower than expected. A lower reading than the forecast would reflect larger lags in wages. But from the RBA’s liaisons in November, more firms are providing larger wage increases over the coming year. Thus, Citi Research’s view remains that the RBA will continue hiking by 25bps across Dec and Feb, for a terminal rate of 3.35% in 2023.

• EUR: Euro Area Recession Watch: Investor Confidence showing turning point? Germany’s ZEW investor confidence survey is often a good early indicator for economic turning points. A second successive improvement could suggest that falling gas prices and growing fiscal support could also support business confidence indices such as the Ifo or the PMIs soon.

• EUR: Euro Area : First signs of labour market cooling? Citi Research see the first estimate of Eurozone 3Q 22 employment to show a slowdown in the pace of job creation through the summer, to 0.1% QQ, from 0.5% QQ growth in the previous three quarters. Hours worked may have picked up further, in a sign of further post pandemic normalisation in the number of hours worked per person employed.

• GBP: Labour market tightness to continue After a week in which the soft data showed some tentative signs of moderating, Citi Research expect the first order data next week will re affirm the inflationary challenge facing the MPC. Wage growth in particular, while stabilizing in a headline sense, is likely to show signs of growing more entrenched with regular pay continuing to catch up, likely a bit above the MPC’s November expectation. While labour demand we think will show further signs of moderating, the risk of a shift in the Philips curve is likely to remain very real over the coming months. Citi Research expect this to drive a further 50bps move in December.

• GBP: Inflation to jump October inflation in the UK is also likely to increase in our view with headline CPI jumping to 10.8% YY. The Bank expect 10.9%. The main driver here is the move to a new Ofgem price cap, which alone is likely to add 60bps to headline inflation. Citi Research believes RPI will print at 14.1% YY. The marginal downside surprise versus the Bank’s forecast primarily reflects the impact of the tuition fee freeze in place over the coming years. Otherwise, Citi Research think underlying momentum remains robust. This will likely keep rates elevated through Q4, although Citi Research expect inflation to begin to fall back through 2023.

• CNY: Industrial Production (%YoY) YoY): Citi Forecast 0.8, Consensus 1.6, Prior 0.9; CPI (%YoY): Citi Forecast 6.0, Consensus 5.2, Prior 6.3 IP growth could moderate to 6.0%YoY in October Industrial activity could soften in October as Mfg PMI dropped to below 50. That said, the YoY reading could stay solid thanks to a low base from last year production suffered heavily from the power crunch last year. The heavy sectors could be doing okay our high frequency trackers indicated gradual recovery post the National Day holiday. The daily average of crude steel output stayed at double digit for the first 20 days of October.

• CNY: Retail Sales (%YoY): Citi Forecast 1.0, Consensus 0.7, Prior 2.5 R etail sales growth could dip to 1.0%YoY The Covid situation and tightening measures around the Party Congress were not favorable for consumption in October. The Golden Week consumption data was quite soft, and the services PMI dipped further in October. Restaurants’ revenue could suffer as a result. Auto sales also seem to be coming off the strength the volume growth of sales could inch down to 11.4%YoY from 21.5%YoY in September (CPCA, Oct 24, 2022). The base effect could be another unfavorable factor retail sales had a post Covid rebound last October.

• CNY: Fixed Assets Ex Rural YTD (%YoY) Citi Forecast 5.9, Consensus 5.9, Prior 5.9 FAI in October could again be a race between infrastructure push and property woes. Issuance of local government special bonds resumed and reached over RMB400bn in October . On the ground, operation rates of cement mills and asphalt plants both stayed resilient after returning from the National Day holiday. Manufacturing investment could benefit from newly added policy push. Property investment could be slow to bottom out. The MoF clarified that local governments were not allowed to inflate the land sales numbers through SOEs in October. It could weigh on land sales in certain cities.