Chart of the Week: Mr Abe’s Margin of Safety Getting Thinner

Recent Japanese data have been pointing to a downshift in the economy’s momentum, emphasised by a slowdown in private consumption. Although this is not likely to have direct policy implications in the near term, the path of least resistance for policy is for more action by the Bank of Japan.

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The message from last week’s Japanese economic data was consistent with a deceleration in the economy’s momentum, emphasised by a slowdown in private consumption. Annualized GDP growth for Q3 came in at 1.9% – down from 3.8% in Q2 and an upwardly-revised 4.3% in Q1. Private consumption was up a mere 0.4%, but the contribution from net exports was negative, driven by a surge in import growth. Weakness in trade and consumption was offset by strength in inventories and a rising public investment.

A slowdown in consumer spending is not surprising after three straight quarters of strong growth. It is natural to expect the initial sugar-high from QQE to ease with time and the wealth effect from the stock market rally to fade somewhat. The slowdown also casts doubt on how much more front-loading of consumption there will be ahead of April’s VAT hike.

Slowly but surely, however, the numbers point to a passing of the baton from the first arrow of Abenomics (monetary easing) to the second (supplementary budget spending) as the primary contributor to economic growth. But, as we have been arguing for a while, reliance for growth on the fiscal side is not a sustainable option for Japan – both with regards to the much-needed bolstering of its potential growth rate and in view of the country’s already stretched public finances.

Meanwhile, the weaker yen continues to have an asymmetric impact, hurting household real incomes more than it benefits trade activity. Noticeably, consumer confidence dropped sharply in October to a reading of 41.2 – the lowest since December 2012 – with respondents most pessimistic about income growth and rating “overall livelihood” conditions even lower at 37.7. As long as wage growth fails to keep up with inflation, Mr Abe’s experiment is likely to backfire.

Though there are differences, an analogy can be drawn between QQE in Japan and QE2 in the US. When the Fed responded to the rising threat of deflation in 2010 by announcing a second round of unconventional easing, the initial boost to consumer confidence lasted for only about six months. The subsequent period was marked by rising inflationary pressures – annual CPI went from 1.1% in August 2010 to 3.8% a year later – which ultimately weighed on US consumer confidence. In Japan, where the aim is to dispel entrenched deflation by making higher inflation and inflation expectations a stated policy objective, it is the combination of anaemic wage growth and currency weakness that is keeping real incomes depressed. And of course the underlying cause of weak real income growth is weak productivity – just as in the UK. And in both cases, the as yet unfixed banking system is playing a significant role in retarding productivity growth.

Although last week’s dataflow is unlikely to have direct policy implications in the near term, the path of least resistance for policy is for more action by the Bank of Japan: the bar for additional monetary easing appears to be moving lower. Investors seem to agree. Local equities gained more than 7% last week, outperforming most other indices and the yen broke through the 100 level again, consistent with the market moving to discount a renewed loosening of the monetary taps sooner rather than later.

 
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