Japan: Economy shows signs of rebound

Growth trends: Economy recovers on the back of strong consumer spending

The Japanese economy appears to be rebounding after a decline in real gross domestic product (GDP) in the first quarter of 2018. Real (inflation-adjusted) GDP increased at an annualized rate of 1.9 percent from the first to the second quarter.¹ This follows a contraction of 0.9 percent in the first quarter. Second-quarter growth was the fastest since the third quarter of 2017. Real consumer spending grew at an annual rate of 2.8 percent, while investment in housing fell at an annual rate of 10.3 percent. Investment by business was up at a very strong rate of 5.2 percent. Exports were up at a modest rate of 0.8 percent, while imports grew at a strong rate of 3.9 percent. Thus, it appears that, at least for the second quarter, growth in Japan was likely more a function of domestic demand than of exports, a shift that the government was hoping to see. Moreover, this is welcome because there is considerable risk to the global trading system, given the burgeoning trade war between the United States and China, both important trading partners for Japan. The revival of consumer spending is likely due to the tightness of the labor market and the positive impact of this on household income. The rise in labor costs has likely compelled businesses to invest in “labor-saving” technology, thus boosting capital spending.

Retail sales were up 1.8 percent in June versus a year earlier, the fastest rate of increase since December 2017.² Sales rose strongly at department stores, and moderately at general merchandise and food stores; they fell at apparel stores and automotive dealerships. Nonetheless, sales were up very strongly at petrol stations, reflecting the sharp increase in energy prices from a year ago. Whether retail sales growth will be sustained in the months ahead will depend in part on how the economy responds to very low unemployment. Currently, at 2.2 percent, unemployment is at a 25-year low.

Policy: Central bank assures “continuous powerful monetary easing”

Many investors were concerned about the potential impact of the policy meeting of the Bank of Japan (BOJ) in late July. They anticipated a significant shift in monetary policy that could lead to much higher bond yields and a stronger yen. Indeed, concerns were such that yields rose enough for the BOJ to intervene in the market on three occasions to prevent the 10-year yield from rising above 0.1 percent.

Nonetheless, investor concerns eased after the BOJ indicated that nothing much had changed. Rather, the BOJ statement mentioned that the bank will pursue “continuous powerful monetary easing”³ and that it will keep interest rates historically low. Moreover, the BOJ intends to maintain low interest rates “for an extended period of time.” This kind of forward guidance, common for some central banks, is new for the BOJ. The central bank’s governor, Haruhiko Kuroda, said that its statements “will fully counter speculation among some market participants that the bank is heading [toward] an early exit or an increase in rates.” In response to the news, Japanese bond yields fell as the value of the yen fell as well.

The BOJ has maintained an unusually aggressive monetary policy for several years, which involved negative interest rates and massive asset purchases—so much so that the BOJ’s balance sheet is now 98 percent of the GDP compared to the US Federal Reserve’s 20 percent. Yet despite this aggressive posture, inflation remains historically low in Japan. The BOJ remains confident that inflation will eventually rise to the bank’s target. It stated that “the momentum toward achieving the price stability target of 2.0 percent is maintained but is not yet sufficiently firm.” Japan is characterized by deflationary psychology and a declining population, both of which likely contribute to very low inflation.

Trade: Government takes steps to mitigate possible risks from the US–China trade dispute

One of the biggest risks to the Japanese economy stems from the US–China trade dispute. Japan’s manufacturing and technology sectors could be hurt if the dispute were to cause a significant disruption to Asian supply chains. As such, it is not surprising that Prime Minister Shinzo Abe has stated that Japan intends to boost its economic relations with China.⁴ This is seen as a possible response to US protectionism. Japan stands to be hurt by US tariffs on Chinese goods, many of which include Japanese components. Thus, from Japan’s perspective, it makes sense to find ways to reduce its exposure to the United States. Japan clearly wants to boost exports to China, while China would likely want to see more Japanese investment in China. The latter would be helpful in improving the technical capabilities of the Chinese industry.

Meanwhile, although Japan wants to boost its economic relations with China, it is wont to see China dominate trading relations in the region. As such, Japan has played a key role in reviving the dormant Trans-Pacific Partnership (TPP), which was sidelined after the United States withdrew from it in January 2017. Japan, Australia, Canada, and the other original signatories to the TPP have agreed to pursue free trade, in part as a way to offset the efforts of China to organize trade in the region.