Japan's Q2 GDP: No show-stopper

While a touch firmer than the consensus expectation, it’s hard to argue that Japan’s Q2 GDP figures, released earlier today, weren’t weak. GDP fell 6.8%Q/Q annualised (1.7%Q/Q), just a whisker short of the quake-related drop in Q111, as output recoiled rapidly having leapt 6.1%Q/Q ann. in the quarter ahead of April’s consumption tax hike.

Within the detail, consumer spending plunged 18.7%Q/Q ann., the sharpest drop on the series going back to the early 1990s. Consumer spending on durable goods plummeted more than 55%Q/Q ann.! The decline in private residential investment was also extreme, down 35%Q/Q ann., the steepest in more than five years. Private non-residential investment dropped almost 10%Q/Q ann., the weakest quarter in more than two years. And to rub salt into the wounds, exports fell too, for the first quarter in three and by 1.8%Q/Q ann.

On the positive side of the ledger, given the deep drop in domestic demand, imports fell more than 20%Q/Q ann., and so net trade contributed a whopping 4.4ppts to annualised GDP growth, the most in five years. Stock-building also made a very large contribution, almost 4ppts to annualised growth, the most since Q408, suggesting however that this component might well subtract significantly from growth in Q3. And while extra public spending slightly softened the blow too, with government consumption and investment jointly contributing just 0.2ppt to annualised growth it’s tempting to think that Abe’s supplementary budget implemented earlier in the year should have been far more generous.

On the inflation front, meanwhile, the increase in the consumption tax saw the domestic demand deflator rise 1.4%Q/Q in Q2, the fastest pace since the early 1990s, to leave it up 2.4% compared with a year earlier, similarly the highest rate since Q391.

Of course, a marked retrenchment in GDP in the aftermath of April’s consumption tax hike was inevitable. And the headline numbers are exaggerated by increases of often similar magnitudes in the first quarter. But being almost twice the size of the decline in the quarter following the previous consumption tax rise in 1997, some critics will no doubt argue that fiscal tightening was premature and has dealt a lasting blow to the recovery. Others might carp at the BoJ, and argue that it should have provided additional easing already to restore momentum.

But we see no major cause for panic. While it is difficult to gauge the underlying strength of the economy, today’s data are unlikely to represent a lasting turn for the worse in the fortunes of Abenomics. Nor do they necessarily merit extra aggressive policy action from the BoJ. Indeed, there appear several reasons to expect a fairly vigorous rebound in the present quarter and beyond in most demand components. In particular:

  • There are already signs (e.g. vehicle sales figures) that household spending is starting to recover in the third quarter. With consumer confidence up to an eight-month high last month, employment growth vigorous, and an increasingly tight labour market offering the prospect of further employee income growth (up 1.3%Y/Y in nominal terms in Q214), households should offer support to growth in coming quarters too. 
  • Private non-residential investment fared better than many had feared in the past quarter, with the drop reversing less than one third of the surge in Q114, suggesting that the underlying momentum for capex remains positive. Certainly, the outlook for profits remains promising, and business confidence remains elevated. And surveys continue to flag a step–up in fixed investment in coming quarters against the backdrop of capacity constraints. Indeed, June’s machine orders data, due tomorrow, are expected to show a jump of more than 15%M/M, signalling the likelihood of a rebound in non-residential investment in the present quarter. 
  • While exports have been a repeated source of disappointment since the quake, the data for the first twenty days of July were the strongest in four months. And with global demand hopefully set to take a turn for the better in the second half of the year, if Japanese exporters can maintain their present share of global trade, exports should rise in H214 at the firmest pace since H113. 
  • Meanwhile, construction orders data suggest that there’s still more moderate support to come from public expenditure too. And, of course, yet another supplementary budget can never be ruled out.

Overall, we think that GDP growth in excess of 4%Q/Q ann. in the present quarter does not look fanciful with prospects good for above-potential growth thereafter too. That should pave the way for Abe to give the green light to the further 2ppt consumption hike in October 2015. And it is unlikely to cause the BoJ to revise significantly its upbeat assessment of the economic outlook. Indeed, unless growth in Q314 ends up being a huge disappointment, and underlying inflation starts to slip back below the 1% level that Kuroda seems to think is impregnable, the BoJ looks unlikely to provide extra monetary support. Instead, despite today’s weak data, expect the BoJ merely to plough on with QQE in its current form into 2015.

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