Japan: Maintaining the momentum

Fuelled by optimism over the new government’s policy initiatives and the weaker yen, Japan’s equity markets have enjoyed their longest winning streak in more than fifty years. Rising each week for the past twelve, the Nikkei is now up about one quarter from its level in mid-November. But does the economic outlook merit such optimism? Maybe.

Certainly, recent data suggest that the economy stabilised at the end of 2012:

  • Having declined in four of the previous five months, industrial production rose in December by 2.5%M/M, the strongest gain in eighteen months. This saw inventories drop to their lowest level since February.
  • Similarly, after dropping to an eighteen-month low in October, export volumes levelled off at the end of the year. With imports falling, net trade no longer seems to be a drag on growth.
  • Household spending on ‘core’ items rose 0.8%Q/Q in Q412, suggesting that private consumption provided modest support to growth in the final quarter.

This more positive tone to the data has also been evident at the start of the year. Exports were up almost 15%Y/Y in the first ten days of January, the strongest such rise since May. And manufacturers expect to boost output by more than 2%M/M in January and February. So, the economy appears to be on the mend.

And that has come even before recent policy announcements have had time to work. When the impact of the new government’s economic policies are added in to the equation, we are even more persuaded that Japan’s economic recovery will gain traction over coming quarters. In particular:

  • The announced fiscal stimulus will boost GDP growth by around 0.7ppts over the coming fiscal year.
  • The weaker yen – partly the result of the BoJ’s latest policy shift – should see net trade boost GDP growth by 0.5ppts or more over the coming fiscal year.
  • The looming 3ppt increase in the consumption tax rate to 8% from April 2014 means that households will bring forward big-ticket purchases to Q413 and Q114, leading to an acceleration in growth at the turn of the year.

These factors have led us to more than double our growth forecast for the coming fiscal year to more than 2%, an upwards revision unmatched by any other major economy.

But while we are upbeat about the prospects for growth up to Q114, beyond that the outlook is less sanguine. On current plans, public spending will decline sharply in FY14 to subtract significantly from growth at precisely the same time as the consumption tax hike hits demand. So, without further significant stimulus, we are looking at a marked contraction in GDP well in excess of 1%Q/Q in Q214, and no resumption in growth before the final quarter of the year. Moreover, with a further increase in the consumption tax pencilled in for October 2015, the outlook for FY15 looks hardly more encouraging.

Given this, it seems doubtful that Abe will be able to resist the temptation to provide more fiscal support – most likely via extra public works spending – through FY14 to cushion demand. But that might still not be sufficient to prevent fiscal policy subtracting from demand in both FY14 and FY15. So, the onus will be on the BoJ to try and maintain the recovery if Japan is indeed to be jolted out of its deflationary lull once and for all.

Indeed, if it is serious in meeting its new 2% inflation target on a sustained basis, the BoJ’s commitment made last month to increase its stock of asset purchases through to at least the end of 2014 should represent just the start. When its next policy meeting concludes on 14 February we would be surprised if Masaaki Shirakawa, the Bank’s risk-averse current Governor, unveils further easing. But when his successor takes the helm at April's meetings, a further increase in the BoJ’s purchases of public and private sector securities looks to be the bare minimum he needs to deliver.

And, as we have seen before – not least at the ECB – a change in central bank leadership can often prompt significant policy innovations. So, we do not rule out the possibility that the incoming team at the BoJ might unveil the kind of innovative and aggressive policies required to sustain Japan’s economic recovery into FY14 and beyond. If that was to prove the case, Japan’s economic prospects could truly be transformed. And that would no doubt be cause for celebration by Japan’s equity markets too.


Chris Scicluna, Head of Economic Research

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