Natural disasters hit Japanese growth
- Weakness across the board as Japan hit by flooding, earthquake and typhoon
- Government-led reconstruction spending to precipitate fourth quarter rebound
- Risk of monetary policy tweaks ahead of 2020 consumption tax hike
Suffering from a series of natural disasters over the summer, the Japanese economy contracted in the third quarter, with real GDP growth falling by 0.3% quarter on quarter (q/q). This was widely expected due to the scale of the disasters and a deterioration in monthly activity indicators. It also continues a stop-start year for Japan, which contracted in the first quarter (again, mainly due to weather), but rebounded strongly in the second.
Fall in domestic and external demand
Consumption, which accounts for over half of Japanese GDP, fell by 0.1% q/q, taking 0.1 percentage point (pp) off GDP growth. Investment was disappointing, falling by 0.5% q/q, resulting in another 0.1pp drag to growth. The main weakness within investment was from public investment and inventory, including finished goods and materials, contribution and business investment (capex) fell by 0.2% q/q, making no contribution to growth.
Net exports were a drag to real GDP growth of 0.1pp. Weaker imports - consistent with the fall in domestic consumption - contributed positively, but not enough to offset the 1.8% q/q decline in exports, which wiped 0.3pp off growth.
Disentangling underlying growth from the impact of natural disasters is difficult. We expect there is some moderation in the underlying growth of the Japanese economy; consistent with a moderation in monthly activity indicators. In particular, while disruption to production was an important element of the contraction in exports, underlying export growth had already been moderating.
The weak capex warrants some attention as surveys of companies’ intentions remained strong over the quarter and corporate fundamentals continued to hold up, with Japanese companies continuing to demonstrate healthy profitability. We cannot rule out any contagion to investment spending from the recent moderation in sentiment seen in business surveys.
Stop-start year for Japanese growth to continue
We expect a continuation of a stop-start year for Japan going forward. In the short term, we could expect to see growth rebound into positive territory in the fourth quarter, helped by reconstruction spending with the government having approved a disaster recovery supplementary budget worth 0.2% of GDP. The magnitude of the bounce back will give an indication of the underlying momentum of the Japanese economy.
Looking ahead, 2019 may also prove a volatile year for Japan in terms of activity. Prime Minister Abe recently reaffirmed his intention to raise value added tax (VAT) - otherwise known as the consumption tax - from 8% to 10% in October next year. Previous VAT hikes have typically had a large impact on activity. Despite the Cabinet looking to offset the impact of the higher consumption tax in 2019 with spending, there is likely to be a subsequent decline in consumer demand as well as some frontloading, a near-term uptick in consumer spending, ahead of the tax rise. Meanwhile, the weaker outlook for global trade suggests that external headwinds are also likely to weigh on the Japanese economy.
Narrow window for further monetary policy tweaks
The Bank of Japan (BoJ) is unlikely to be too fazed by the GDP report given the significant impact of natural disasters. With the consumption tax hike scheduled for next year, we think the BoJ has a narrow window for any additional gradual tweaks to policy, given our expectations that the economy will recover in the latter half of 2020. We see a possibility that the BoJ allows the upper limit of the 10-year Japanese government bond yield to rise another 10-30 basis points due to concerns surrounding the effects of prolonged monetary easing. The short-term interest rate will most likely be kept on hold at -0.1% until 2020.
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