Raymond Van Der Putten
BNP Paribas
The economy is bouncing back after the sharp contraction in Q2, although slower than expected. Industrial production only inched higher by 0.2% in July, whereas unemployment rose to 3.8%. The loss in purchasing power after the VAT hike and the depreciation of the yen is weighing on household spending.
The economy is bouncing back after the sharp contraction in Q2, which was related to the consumer tax hike in April. The diffusion indices of the Economy Watchers Survey, usually a good harbinger for corporate activity, have quickly recovered. Nevertheless, the underlying growth momentum is very weak. External demand has been showing signs of recovering but these might be nipped in the bud because of geopolitical tensions. On the domestic side, substantial losses in purchasing power following the yen depreciation and the VAT hike have been weighing on household expenditure.
These developments also impacted the July data. Industrial production rebounded modestly by 0.2%, after having declined in the two previous months. However, this was well below market expectations (1%). The underlying trend – measured as the annualised three-month rate of change remained firmly in negative territory (-3.2%).
Nevertheless, entrepreneurs remain rather positive on the outlook. According to METI’s survey of production forecast, output could expand by 1.3% in August and even 3.5% in September. Moreover, according to the Economic Watchers Survey, the diffusion index for expectations of businesses mainly serving other businesses has been around 53, indicating that most firms expect production to expand. However, this is only a rebound following the plunge after the tax hike rather than signalling a strong recovery. Orders remain relatively low. In Q3, total machinery orders are expected to decline by 15.3%, mainly due to a sharp fall in overseas orders, which will completely wipe out the gains in Q2 (14.4%). Also core machinery orders are on a downward trend.
The labour market performance has remained quite resilient. It is true that the unemployment rate inched up by 3.8% in July, while the job-to-applicant ratio seems to be flattening out at 1.1. However, employment was 0.7% higher from a year earlier. It is also quite interesting that the labour force is growing again (0.6% y/y), which suggesting that the government’s policy of getting more people into the labour market is bearing fruit. Indeed, more women are entering the labour market (1.8% y/y in July).
Employment creation was especially strong in construction (+200k from a year earlier), thanks to the government’s investment programme. In this sector, labour shortages have been reported. Jobs have also been created in communications and transport. By contrast, employment has fallen sharply in the whole sale and retail sector (-170k in July). The weakness in this sector was also reported by the Economy Watchers. In the coming months, employment growth may come to a standstill.
In July, consumer prices were 3.4% higher from a year earlier, partly due to the tax hike, which contributed about 2 percentage points to overall inflation. In addition, prices have been boosted by higher import prices, in particular for fuels, following the weakness of the yen. In July, import prices were 2.7% higher from a year earlier. However, given the weakness in consumption following the VAT hike, many retailers find it difficult to pass these price increases to their customers. Prices excluding taxes, food and energy were only 0.3% higher from a year earlier. The Tokyo data for August inflation suggest that inflation could have inched down further this month.
The rise in consumer prices is not compensated by wage hikes. In June (latest observation), wages were only 1% higher from a year earlier, thanks to higher bonuses and more overtime. Contract wages rose by only 0.4%. The small increase is partly related to the pay structure in Japanese enterprises, which is much more age-related than in order countries. The departure of older workers and the recruiting of school-leavers have a negative effect on the average.
In July, real disposable income for workers’ households rose by 1.1% thanks to the summer bonuses. This allowed them to loosen the purse strings a bit. Their expenditure rose by 1.7% in real terms. This was not the case for the rest of the population. Even though the effect of the VAT hike is waning, consumer expenditure is still declining due to significant losses in purchasing power. Compared to a year earlier, real spending was about 6% lower in July from a year earlier.
Even though consumer price inflation is below the BoJ target (2%, excluding VAT hike), the economy is out of deflation. The government’s expansionary fiscal and monetary policies have also brought other benefits such as a significant improvement in labour market conditions and higher profits, in particular for the large exporting firms. However, the benefits have not been evenly spread among the population. Many may feel poorer as prices increases have not been compensated by higher wages and benefits. This has been clearly weighing on domestic spending and the overall economy.
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