News in Charts: Japanese economy faces an uncertain start to its new imperial era

Fathom’s Japan Economic Sentiment Indicator (ESI) fell sharply in March, to its lowest level in two-and-a-half years, signalling growing worries about the country’s economic health. The ESI combines various ‘soft’ data such a business and consumer surveys into a single measure of underlying sentiment.

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The 1.3 percentage point fall, to a level of 1.9%, in the first quarter of the year mirrors disappointing hard data for Q1, such as significant drops in retail sales and industrial production. Core machinery orders, which are a useful indicator of investment in the economy, often with a short lead, have been falling this year. Gross fixed capital formation, which was the largest contributor to GDP growth last year, seems unlikely to be as supportive of economic growth in 2019 Q1 as it was in the previous quarter.

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Net exports, which buoyed economic growth in 2016 and 2017 and arguably contributed to strong sentiment over that period, stagnated last year as China, Japan’s largest trading partner, experienced a slowdown in its domestic economy. While Japan’s trade deficit in goods fell marginally in 2019 Q1 due to a small surplus in February, the country’s exports and share of foreign machinery orders fell, suggesting that external demand has failed to rebound substantially and make a significant contribution to GDP growth.

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As we anticipated, the gap between soft and hard economic data has narrowed as sentiment has fallen — Japan’s economy may once again fail to take off as inflation remains stubbornly low, and the country continues to flirt with recession. The current period is reminiscent of the pre-crisis period of 2005-2006, when sentiment was strong and many hoped that the country’s economy was reaching ‘escape velocity’ to maintain robust growth and escape deflation. While a global crisis of the magnitude seen during the Great Recession may not be imminent, Japan faces economic hurdles in the year ahead that will present a challenge to a strong economy. The government remains committed to its consumption tax hike later this year, which is likely to depress domestic consumption, and uncertainties around global trade remain.