The challenges in Japan’s economy will cause a dilemma for the BOJ, making it difficult to pivot towards monetary tightening
Japan has unexpectedly slipped into recession, losing its title as the world’s third-largest economy to Germany. This sudden change is raising questions about the timing of Japan’s central bank exiting its decade-long ultra-loose monetary policy. The economic landscape is clouded by weak demand in China, sluggish consumption, and production halts at a unit of Toyota Motor Corp, all signaling a challenging path to recovery.
The latest government data revealed that Japan’s gross domestic product (GDP) fell an annualized 0.4% in the October-December quarter, defying market forecasts for a 1.4% increase. This follows a 3.3% slump in the previous quarter, meeting the technical definition of a recession with two consecutive quarters of contraction.
Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute, highlighted the concerning aspects of the economic slowdown, stating, “What’s particularly striking is the sluggishness in consumption and capital expenditure that are key pillars of domestic demand.” With private consumption, constituting over half of the economic activity, falling 0.2% against market expectations for a 0.1% gain, and capital expenditure dropping 0.1%, the challenges for Japan’s economic recovery become apparent.
The weakened domestic demand has implications for the Bank of Japan’s (BOJ) plans to phase its substantial monetary stimulus this year. While many analysts had anticipated this move, the disappointing data may cast doubt on the BoJ’s forecast that rising wages will support consumption and maintain inflation around its 2% target.
Economy Minister Yoshitaka Shindo emphasized the importance of solid wage growth to strengthen consumption, which he described as lacking momentum due to increasing in prices. However, the hurdles for the BOJ to justify a rate hike have increased with two consecutive declines in GDP and three in domestic demand.
The Yen, on the other hand, remained steady after the data release, standing at 150.22 per dollar, near a three-month low. Yields on Japanese government bonds fell as some traders pushed back bets of an early BOJ policy shift, with the benchmark 10-year yield sliding 4 basis points to 0.715%. The Nikkei stock average rallied to 34-year highs, reinforcing recent assurances from the BOJ that borrowing costs will remain low even after ending negative rates.
The challenges in Japan’s economy will cause a dilemma for the BOJ, making it difficult to pivot towards monetary tightening. Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities, stated, “Weak domestic demand makes it hard for the BOJ to pivot towards monetary tightening,” noting that the hurdle for ending negative rates in March has risen.
External demand, driven by exports, contributed 0.2 percentage points to GDP, with exports rising 2.6% from the previous quarter. However, this positive factor may not be sufficient to counterbalance the overall economic slowdown.
As Japan navigates these economic challenges, global attention turns to Germany, now the world’s third-largest economy. The unexpected shift in rankings underscores the dynamic nature of the global economic landscape. Experts are monitoring Japan’s labour market and corporate spending plans, debating the possibility of an early exit from ultra-loose monetary policy.
The International Monetary Fund’s January forecast, while revising up global growth expectations, warned of geopolitical tensions in the Middle East. Against this backdrop, the BOJ faces the delicate task of managing its monetary policy amidst uncertainties in the global economic environment.
Japan’s unexpected recession marks an important development with far-reaching implications for global economic dynamics. As Germany currently takes up the third position in the global rankings, questions still arise about the Bank of Japan’s ultra-loose monetary policy and broader impact on the international economic landscape. The intricate interplay of domestic challenges and global economic shifts will shape the trajectory of Japan’s recovery and influence central bank policy decisions in the coming months.
