Start with the conclusion…
Bottom line: Japan is flying low. And it’s not just the earthquake. All the more, therefore, the Bank of Japan will eventually have to expand its asset purchase program further.
Just don’t expect an announcement on this at tomorrow’s MPC meeting just yet. It’ll be a few more months before additional measures will be taken.
Need another crank: Japan’s economy slumped in the first quarter Need another crank Japan’s economy slumped in the first quarter
True, the recent data flow wasn’t too bad. The economy started to pick up a little faster in recent weeks than one had dared hope. But that’s little
consolation: first quarter GDP fell sharply. What’s more, a sizeable downward revision to the previous quarter indicates that Japan’s economy is stuck in a dangerously low orbit. Thus another boost will be needed from the Bank of Japan. Don’t expect an announcement at the meeting tomorrow.
But, an expansion of the central bank’s asset purchase program looks now more likely.
Facts
Preliminary data shows that Japan’s economy contracted 0.9% q-o-q sa in the first quarter. The market had expected a fall of only 0.5%. What’s perhaps more worrying is that GDP growth for the fourth quarter was revised down from -0.3% to -0.8%. Japan, in short, has now seen two consecutive quarters of contraction, and the slump has deepened. On an annual basis, first quarter GDP was down 1% after rising 2.2% in the fourth quarter of 2010.
The ground is slipping.
The details reveal that the recent deceleration was broad-based. The contraction in private consumption spending eased a little to -0.6%, but this is actually a disappointing outcome given the 1% slump in the fourth quarter. Fixed capital formation slowed further and net exports unexpectedly provided a drag on overall growth. The sizeable acceleration in public consumption improved the overall picture a little, but, in reality, this only masks deeper blemishes on private sector momentum.
Implications
It is difficult to attribute the disappointing GDP reading solely to the effects of the March 11 earthquake. True, industrial production slumped at a record pace during the month, with service sector activity also down sharply. However, the event affected only the last three weeks of the quarter and thus doesn’t fully account for the surprising weakness for the whole period. Moreover, the substantial downside revisions to fourth quarter GDP also suggest that underlying momentum wasn’t as robust as widely thought.
Nevertheless, the recent dataflow has turned more positive for April and May. In fact, the disastrous industrial production report for March already contained a glimmer of hope, with firms forecasting a sizeable pick-up in output for April and May. Machine orders, too, rose in March contrary to expectations of a sharp drop. This should further support production in subsequent months. Meanwhile, the outlook component of the April Eco Watchers survey, which gauges sentiments among small business owners, turned up sharply from 26.6 to 38.4, making up about half of the ground lost the previous month. Thus, it is not entirely clear whether the economy will contract further in the second quarter: sequential improvement after such depressed activity appears now quite likely.
This, however, should not be of too much comfort for the Bank of Japan. The real message from today’s GDP release is that even before the earthquake struck the economy has flying in lower orbit than previously thought.
Deflationary pressures, therefore, will prove more persistent than initially assumed. Today’s data, in fact, shows that the GDP deflator sank 1.9% y-o-y, more than expected and quite a bit more than the 1.6% drop in the fourth quarter of 2010.
More monetary policy action, therefore, appears likely. Last month, Deputy Governor Kiyohiko Nishimura called for a further increase in the central bank’s asset purchase program. In the event, his proposal was voted down.
At tomorrow’s meeting, while we don’t expect any change, it will be interesting to see whether his suggestions will be tabled again and whether it will receive any support among other MPC members. With lingering uncertainties over the timing, size, and financing of the second and third fiscal rebuilding packages (the first one is already on its way), it will become likely that the Bank of Japan will eventually have to step up and provide additional support to the economy in the form of a further expansion of its asset purchase program.
Bottom line: Japan is flying low. And it’s not just the earthquake. All the more, therefore, the Bank of Japan will eventually have to expand its asset purchase program further. Just don’t expect an announcement on this at tomorrow’s MPC meeting just yet. It’ll be a few more months before additional measures will be taken.
Frederic NEUMANN,
HSBC Global Research