At the end of last year, Japan unexpectedly entered a recession. It lost its position as the world’s third-largest economy to Germany. This development raised questions about when the central bank would begin to phase out its decade-long ultra-loose monetary policy.
Analysts predict another contraction in the current quarter. They cite weak demand in China, sluggish consumption, and production halts at a Toyota Motor Corp (7203.T) unit. All of these factors point to a difficult path to economic recovery and policymaking.
“What’s particularly striking is the sluggishness in consumption and capital expenditure that are key pillars of domestic demand,” said Yoshiki Shinke. He is a senior executive economist at Dai-ichi Life Research Institute.
“The economy will continue to lack momentum for the time being with no key drivers of growth.”
Government data released on Thursday reveals that Japan’s GDP fell by an annualized 0.4% in the October-December period. This comes after a 3.3% drop in the previous quarter, defying market expectations of a 1.4% increase.
A technical recession is typically defined as two consecutive quarters of contraction.
Many analysts still anticipate the Bank of Japan to scale back its extensive monetary stimulus this year. However, the weak data raises doubts about its forecast. The forecast suggests that rising wages will sustain consumption and maintain inflation around its 2% target for the foreseeable future.
“Two consecutive declines in GDP and three consecutive declines in domestic demand are bad news, even if revisions may change the final numbers at the margin,” said Stephan Angrick, senior economist at Moody’s Analytics.
“This makes it harder for the central bank to justify a rate hike, let alone a series of hikes.”
Yoshitaka Shindo, the economy minister. He emphasized the need for strong wage growth to support consumption, which he described as “lacking momentum” due to rising prices.
“Our understanding is that the BOJ looks comprehensively at various data, including consumption, and risks to the economy in guiding monetary policy,” he told a news conference after the data’s release, when asked about the impact on BOJ policy.
After the data, the yen closed at 150.22 per dollar, remaining steady. It was close to a three-month low hit earlier this week.
Following the data, a decline in yields on Japanese government bonds occurred as some traders withdrew from bets on an early BOJ policy shift. The benchmark 10-year yield dropped 4 basis points to 0.715%. The Nikkei (.N225) stock average surged to 34-year highs. This adds to the BOJ’s recent assurances that borrowing costs will remain low even after negative rates are eliminated.
“Weak domestic demand makes it hard for the BOJ to pivot towards monetary tightening,” said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities. “The hurdle for ending negative rates in March has risen.”
CONSUMPTION, CAPEX WEAK
Private consumption, responsible for over half of GDP, declined by 0.2%, contrary to market expectations of a 0.1% increase. This drop occurred as rising living costs and warm weather dissuaded households from dining out and buying winter clothing.
Another vital private-sector growth driver, capital expenditure, saw a 0.1% decline, contrasting with expectations of a 0.3% increase.
For the third consecutive quarter, both consumption and capital expenditure experienced a decline.
A quarterly survey reveals that large companies anticipate a substantial 13.5% increase in capital expenditure for the fiscal year ending in March. Nevertheless, analysts foresee a delay in actual investment attributable to escalating raw material costs and labor shortages.
The most recent machinery orders data, considered a leading indicator of capital spending, revealed a contraction in November. This development raises doubts about the BOJ’s perspective, which posits that robust investment will bolster the economy.
Exports rising by 2.6% from the previous quarter added 0.2 percentage points to GDP through external demand.
Sources indicate that the BOJ has been preparing to terminate negative interest rates by April and revamp other elements of its ultra-loose monetary framework. However, any subsequent policy tightening is expected to proceed gradually due to lingering risks, as outlined by these sources.
As the US Federal Reserve pauses following aggressive interest rate hikes, an exit from accommodative policy is anticipated. The central bank is widely expected to lower borrowing costs later this year.
In January, the International Monetary Fund elevated its global growth forecast, citing improved outlooks for the United States and China. However, the organization cautioned about potential risks, including geopolitical tensions in the Middle East.
BOJ officials haven’t specified the expected end date for negative interest rates, but many market participants anticipate it in March or April. A January Reuters poll showed economists favoring April as the preferred date to conclude the negative rate policy.
Some analysts suggest Japan’s tight labor market and strong corporate spending maintain the possibility of an early exit from ultra-loose policy.
“The (BOJ) has been arguing that private consumption has ‘continued to increase moderately,’ and we suspect that it will continue to strike an optimistic tone at its upcoming meeting in March,” said Marcel Thieliant, head of Asia-Pacific at Capital Economics, reiterating his prediction that the bank will end its negative interest rate policy in April.
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