In Q2, GDP contracted by 1.7% q/q, thus offsetting the 1.5% rise in the preceding quarter. However, business climate indicators quickly recovered after the tax hike in April, suggesting that the weakness in Q2 is only temporary. Monetary policy is expected to remain unchanged but the fiscal stance could become more accommodative.

  • In Q2, GDP contracted by 1.7% q/q, thus offsetting the 1.5% rise in the preceding quarter. This decline is related to the 3-point VAT hike on 1 April, as households brought their purchases forward to Q1. The substantial swings between Q1 and Q2 make today’s date difficult to interpret.

  • Private consumer declined by 5.2% after a 2.1% rise in Q1. This was much more than expected. As a result, consumer spending in the first half of the year was 0.4% lower compared to the second half of 2013. The decline in consumer spending is partly due to fall in real disposable income. The depreciation of the yen since November 2012 has fuelled inflation, in particular for energy products. In addition, the VAT hike added about 2 percentage points to the rate of inflation. In Q2, the private consumption deflator was 2.6% higher from a year earlier. By contrast, wages have hardly increased. In June, they were only 0.4% higher compared to last year.

  • Another disappointment came from exports, as they declined by 0.4%. However, this was largely a correction after the 6.4% increase in the preceding quarter. In the first half of the year, exports were actually 6.4% higher on the second half of 2013. Due to a change in the base year, these data contrast sharply with the monthly trade statistics, which suggested that exports declined by about 1% both in Q1 and Q2. This would correspond better with world trade data. According to the CPB World Trade Monitor, the growth momentum in world trade was only 0.2% q/q in May.

  • An even more worrying sign was the rise in inventories. The contribution of stocks to GDP growth amounted to 1 percentage point. The increase in inventories has also been observed in the industrial production statistics. It is partly related to the rebuilding of stocks after their decline in the first quarter. However, it may also indicate that sales disappointed due to the sharper than anticipated decline in household demand and a very weak external environment. In that case it is likely that manufacturers will slow their production in the coming quarters to offload their unwanted stocks.

  • The economy is unlike to end up in a technical recession. Business climate indicators quickly recovered after the tax hike in April. In July, the diffusion indices of the Economy Watchers Survey were all comfortably above the 50-mark. Hence, we expect that the weakness in Q2 is only temporary.

  • Against this backdrop, the BoJ is unlikely to change its policy. As long as inflation stays on course to hit the 2% target in early 2016, the Bank will probably refrain from stepping up the rhythm of its asset purchases. However, in view of the upcoming parliamentary elections, the government might be tempted to ease the fiscal stance further. This would also facilitate the implementation of the 2-point VAT hike in 2015. This would lead to a worsening of the government finances. However, the authorities trust that the financing is not such a problem with the BoJ willing to buy ever more JGBs.

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