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August 18, 2023

News in Charts: Is Japan finally on the rise again?

by Fathom Consulting.

After years of stagnation, things finally appear to be looking up for Japan’s economy: GDP growth is strong; inflation is above target and long-term interest rates are beginning to rise. But will it last?

Japan’s economy grew by 1.5% quarter-on-quarter in Q2 (6% annualised), an upward surprise of 0.7 percentage points relative to the consensus, as polled by Reuters. This was the largest upside surprise in 15 years and, aside from the pandemic period, the highest growth rate achieved since 2015. However, beneath the surface, the details were a little less encouraging — while export growth was strong, domestic demand was weak. Moreover, the external environment is likely to sour over the coming quarters — as Fathom pointed out in its latest forecast, Global Outlook, Summer 2023, after its long and variable lags the impact of monetary policy is expected finally to be felt in the euro area and US next year, probably forcing both to enter recession (although the US has a better chance of avoiding this outcome). Further, Japan is unlikely to receive a major boost to growth from China, given the deteriorating economic outlook for the regional hegemon.

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This year has also seen prices rising at their fastest rate since the early 1990s. Whether the Bank of Japan (BoJ) has finally succeeded in breaking the economy out of the low-inflation environment that has plagued it over the past 30 years remains to be seen. On the one hand, the headline CPI measure of inflation appears to have peaked already and wage inflation (which would likely be necessary to sustain higher inflation) remains fairly low. But, on the other hand, falling energy prices play a large part in explaining the recent moderation in inflation, and once the effects of food and energy are purged from the index, it looks more like a plateau than a peak.

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Regardless of whether this period of high inflation proves to be self-sustaining or not, the BoJ has begun to tighten policy in response. So far, this has largely come through some relaxation of its yield curve control policy — yields on ten-year government debt have risen from near zero at the start of 2020 to around 0.6% now.

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One notable side effect of the BoJ’s quantitative-easing programmes (and its yield curve controls in particular) is that the central bank has effectively hoovered up all net issuance of Japanese government debt since 2014. If the recent changes to the BoJ’s policy persist, or if they double down on those changes, then it seems likely that this trend could end.

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All of this hinges on the path for inflation — will it follow a trajectory similar to US inflation (which is now falling towards its target) or one similar to the UK where it has proved more stubborn to contain? In Fathom’s view, after 30 years of fairly stable prices, Japan’s inflation expectations are more firmly anchored than those in the UK. (In truth, they are probably anchored too far below the central bank’s target.) This implies that the current burst of inflation is likely to be more of a blip for Japan than a sign of a new normal. If that proves true, then the BoJ’s policy tightening is unlikely to continue much longer. In short, usual service will soon be resumed.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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