Japanese growth rebounds in Q2 amid buoyant domestic demand

The estimate for Japanese second quarter real GDP growth came in at 0.5% quarter-on-quarter (q/q), rebounding from a 0.2% q/q contraction in Q1. This not only confirmed the temporary slowdown in the Japanese economy in the first quarter but beat market expectations of 0.3% q/q and marks a return of Japanese growth to above potential growth.

Growth was driven by domestic demand, which is encouraging given the weaker outlook for global trade in the second half of the year.

Strong domestic demand

Growth in the second quarter was driven by strong domestic demand, which contributed 0.6 percentage points (pp) to growth.

Domestic demand was driven by consumption and investment. Consumption rose by 0.7% q/q, contributing 0.4 pp to growth alone. This marked an expected rebound from the contraction in consumption in the first quarter, which was due to a temporary spike in inflation.

Investment also helped drive growth, contributing 0.1 pp. Private non-residential investment (capital expenditure or capex) was particularly strong, rising by 1.3% q/q and contributing 0.2 pp to growth. This was consistent with strong capex intentions from the Tankan survey in Q2 and offset contractions in residential and public investment.

Drag from net exports

Net exports were a drag to real GDP growth of 0.1 pp. The contribution from exports to growth has now slowed for three consecutive quarters and in Q2 exports made no contribution to growth. Meanwhile stronger imports, consistent with stronger domestic demand, meant net exports were an overall drag to growth.

Strong print unlikely to change course of monetary policy

The GDP deflator, a measure of inflation, decelerated to 0.1% year-on-year (y/y) in Q2 from 0.5% y/y, mirroring weak inflation developments in Q2. Ultimately it is the weakness in inflation that is the main problem for the Bank of Japan (BoJ) and this positive surprise to Japanese growth should leave the course of the BoJ unchanged. Strengthened forward guidance in the last policy meeting, suggests the BoJ will continue with powerful monetary easing, but steps to allow the 10-year Japanese government bond yield to rise an additional 10 basis points suggests a strong reluctance to ease further.