RaboResearch - Economic Research

Japan: Crawling out of a recession

Economic Comment

  • Japan’s economy contracted more than we expected in Q3
  • Mostly because of weak consumer demand
  • However, the first signs of recovery are there, albeit tentative
  • Meanwhile, Suga has instructed his cabinet to devise a third fiscal stimulus package
  • This package seems to be much smaller than the first two packages
  • Japan might be one of the main economic beneficiaries of the RCEP trade deal
  • Core inflation has been negative for three months in a row
  • That might nudge the Bank of Japan into further monetary stimulus

Q3 GDP was weaker than we expected

Japan’s preliminary Q3 GDP growth came in at -5.9% y/y, which is worse than we expected (-4.7% y/y). Japan’s economy is clearly still very weak (Figure 1). For example, household consumption in Q3 declined by 7.8% y/y (Figure 1), business investment (in fixed capital) declined by 10.5% y/y and exports declined by 15.7% y/y. Thus, compared to a year ago, people in Japan are buying less goods and services, businesses are investing less and Japan is selling less goods and services to other countries.

The economy is recovering though. On a quarter-on-quarter basis, household consumption has gone up by 6.3% in Q3 and exports by 8.6% (both preliminary numbers). The latter is partially helped by the continuing economic recovery of China; Japan’s largest trading partner.

Going forward we expect Japan’s economy to continue picking up, albeit at a relatively slow pace, given that coronavirus cases are still rising in Japan. We have slightly revised down our GDP growth forecast for 2020 to -5.3%, taking into account the worse than expected GDP numbers of the third quarter. For 2021, we expect sizable (at least for Japan) GDP growth of 2.9%, due to base effects, signs of a safe and effective vaccine for Covid-19 being available next year and the global economy recovering. This will help consumer as well as producer confidence.

Figure 1: Japan’s economy is still weak
Figure 1: Japan’s economy is still weakSource: Macrobond, Japanese Cabinet Office
Figure 2: Especially consumer demand
Figure 2: Especially consumer demandSource: Macrobond, Japanese Cabinet Office

Suga orders a third stimulus package

Prime minister Suga has instructed his cabinet to compile a third fiscal stimulus package. The size of the new package has not been decided yet. However, Reuters is reporting that between JPY 10 and 30 trillion has been requested by some members of Japan’s ruling party (LDP). That makes this package (between 2% and 6% of GDP) much smaller than the previous two packages worth a massive total 43% of GDP. Japan’s Economy Minister Yasutoshi Nishimura has stated that the new package is designed to fight the economic effects of Covid-19, improve digitalization and for structural improvements in Japan’s economy (such as shifting to a green society). Given its compared to earlier packages relatively small size and seeming focus on structural improvements instead of cash handouts, the new package is unlikely to revitalize consumer demand much, at least in the short term. Nevertheless, some parts (such as improving digitalization) could help Japan’s productivity in the long run.

RCEP is a boon for Japan

Japan is probably one of the main economic beneficiaries of the Regional Comprehensive Economic Partnership (RCEP) trade agreement, which was recently signed by Japan and 14 other Asian countries (including China). On the of the main reasons is that Japan does not have a free trade agreement with China yet. According to an earlier study by the Peterson Institute, RCEP will add about 0.9% to Japan’s real income by 2030 (only to be surpassed by South Korea, 1%). However, RCEP should not be interpreted as a cure for trade tensions (and thus for trade barriers). Non-tariff barriers to trade tend to be more important than tariff barriers (see for example here and here). Thus, the political tensions between China and Japan could still negatively affect trade between the two countries.

More stimulus from the BoJ is possible

Core inflation (excluding fresh food) in Japan came in at -0.7% y/y for October, which is the lowest figure since 2011. It also means that core inflation now has been negative for three months in a row (Figure 3). Although mostly driven by economic weakness, inflation has not been helped by a strengthening of the Japanese Yen (against USD) this year (Figure 4). Overall, this corroborates our view that Japan is walking deeper into deflationary territory. The BoJ itself has acknowledged that inflation “is likely to be negative for the time being” in its Summary of Opinions, although the BoJ expects inflation to return positive when the economy recovers.

Figure 3: Core inflation has been negative for three months in a row
Figure 3: Core inflation has been negative for three months in a rowSource: Macrobond, Japanese Statistics Bureau
Figure 4: Inflation has not been helped by a strengthening of JPY against USD this year
Figure 4: Inflation has not been helped by a strengthening of JPY against USD this yearSource: Macrobond, Japanese Statistics Bureau

We agree that inflation in Japan is likely to return positive next year, when the economy picks up. However, we think deeply entrenched low inflation expectations will keep inflation well below BoJ’s target of 2%. Therefore, we continue to think that the BoJ’s monetary policy stance will remain highly accommodative for a long time. In the short to medium term, additional monetary stimulus is more likely than less stimulus. As we have mentioned before, some triggers for additional monetary stimulus could be a rapid increase of coronavirus cases in Japan, a sharp strengthening of the Japanese Yen or core inflation quickly becoming more negative.

Table 1: Economic forecasts
Table 1: Economic forecastsSource: RaboResearch
Raphie Hayat
RaboResearch Global Economics & Markets Rabobank KEO

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