GDP in Q2 contracted sharply by 6.8% q/q ann

Market movers today

• Focus will remain on uncertainty related to the situation in Ukraine (see more below). In terms of data releases the main event is US retail sales for July, where we expect a modest 0.2% m/m increase. This should follow as the temporary boost from the weather slump in early 2014 continues to wane. Excluding autos and gasoline retail sales are expected to show a more healthy gain, so the underlying trend remains OK.

• In the UK the Inflation Report from Bank of England (BoE) will be released. In light of falling unemployment and improvement in other labour market indicators BoE could indicate that labour market slack has been reduced faster than expected and it could pave the way for an interest rate hike later this year. Interestingly, the labour market report for June will be released just ahead of the inflation report.

• In the euro area we expect industrial production to have increased 0.6% m/m in June, which is a bit more than consensus. However, we believe there is mainly upside risk to our forecast due to relatively strong data in France and Italy recently.

• New York Fed president Dudley (dove, voter) and Boston Fed president Rosengreen (dove, non-voter) are scheduled to speak this afternoon in connection with a conference covering Risks of Wholesale Funding. It will probably be technical presentations with no views on overall monetary policy. That said, Dudley’s views are important because they are believed to be close to chairwoman Yellen’s.

Selected market news

Yesterday most equities declined as uncertainty about Ukraine returned after Russia sent 280 trucks carrying what it said was humanitarian aid for eastern Ukraine. Kiev said any unilateral attempt to deliver aid would be viewed as an act of aggression, see WSJ. The risk sentiment was affected by a new decline in the German ZEW expectations. Despite the recent weakness in data, Bundesbank President Weidmann said yesterday that the central bank sticks more or less to its forecast (GDP of 1.9% in 2014 and 2% in 2015).

In Japan a sharp contraction in GDP in Q2 suggests that the consumption tax hike in April will not prove to be a cakewalk for the economy after all. GDP in Q2 contracted sharply by 6.8% q/q ann. (consensus: 7.0% q/q ann.) after expanding 6.1% q/q ann. in Q1. The details were relatively weak but the sharp contraction in Q2 is to some degree due to temporary factors, as a lot of private consumption has been frontloaded ahead of the tax rise and we expect Japan to return to positive growth in Q3. Nonetheless, the data suggest that the net negative impact from the consumption tax rise was substantial and has been larger than in 1997, when Japan also raised the consumption tax.

The implication is that additional monetary easing is back on the agenda in Japan. Today’s data will not in itself be enough to force more easing from Bank of Japan (BoJ) but it depends on the recovery in Q3. We expect BoJ to soften its statements in the coming months and emphasise increasing downside risk. At its meeting end-October BoJ will probably lower its growth forecast and here further easing looks likely.