The Tankan and QQE: Carry on Regardless

Three months on from the consumption tax hike and Japan’s economy looks to be absorbing the shock as well as might reasonably have been hoped. Despite the hit to demand and production in April, recent surveys suggest businesses remain upbeat about the economic outlook. And that was the overall message from today’s Tankan survey, which suggested that:

  • Growth will resume by end-summer
    The tax hike inevitably saw the Tankan’s headline indices ease back over the second quarter. But the 5pt declines for large manufacturers (to +12) and large non-manufacturers (to +19) left both still above their long-run averages and firmer than in most of 2013, when the recovery was established. With the large manufacturers’ index forecast to rise 3pts in Q3, and the equivalent index for large non-manufacturers expected to move sideways, moderately above-potential growth looks on the cards.
  • A broader-based recovery is in store
    After growth last year was driven by consumption and public spending, the recovery looks to be broadening out. Firms are more upbeat about the outlook for sales and profits, and have also revised up significantly their capex plans for coming quarters. That is particularly true of large manufacturers, whose fixed investment spending is set to rise 12.7% in FY14, an upwards revision of more than 5ppts. This would represent the strongest performance in nine years. The Tankan also suggested a modest improvement in external demand too.
  • Capacity constraints tightest since 1992
    Japan’s labour market is tight. The unemployment rate is at its lowest since 1997, while the ratio of new jobs to applicants is at its highest in more than two decades. The Tankan, meanwhile, indicated that firms in the non-manufacturing sector continue to report staff shortages, and that is also starting to be true for manufacturers. More broadly, a composite output gap indicator derived from Tankan indices suggests that capacity constraints in Q3 might be the tightest since early 1992 (see chart below). That should help sustain inflation in positive territory.
  • But few signs of accelerating inflation
    After more than fifteen years of falling prices, however, it is no done deal that above-potential output will generate significantly higher inflation. According to the Tankan, more large non-manufacturers are increasing their prices than at any time in the past six years. But those firms also expect price pressures to ease off a touch in Q3. And, exposed to more intense competition, on balance, manufacturers still expect their prices to decline in the coming quarter.
  • Wage growth remains minimal
    Further labour market tightening should push wages higher, providing a new impulse to inflation. And other data released today revealed the third consecutive year-on-year increase in labour earnings, up 0.8%Y/Y in May. That was in large part thanks to rising bonus payments and overtime earnings. But while basic salaries rose on the same basis for the first time in more than two years, at a mere 0.2%Y/Y that rate has a long way to rise before the BoJ can have any confidence that its 2% inflation target is within reach.

So, the broadly upbeat tone to the Tankan survey, coupled with the firm tone of most recent data, diminishes the case for the BoJ to provide additional near-term stimulus. But with achievement of its inflation target still some way off, there is also certainly no case either for it even to start considering its exit strategy. Instead, expect the BoJ to plough on relentlessly with QQE, maintaining its asset purchases at the current rate into 2015 and likely beyond too.   

Output gap & BoJ Tankan composite capacity indicator*Tankan1 - Output gap*Composite capacity indicator is weighted average of the BoJ Tankan production capacity and employment condition DIs. Diamond represents Tankan survey forecast in Q314. Source: BoJ, Cabinet Office and Daiwa Capital Markets Europe Ltd.  

BoJ Tankan: Output prices*Tankan2 - Output prices*Diamonds represent Tankan survey forecast in Q314. Source: BoJ and Daiwa Capital Markets Europe Ltd.

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