Japan: July data suggest the economy is only recovering slowly after tax hike

The data released overnight again disappointed and suggest that the recovery in the wake of the consumption tax hike in April will be weaker than expected, albeit Japan will return to positive GDP growth in Q3 after contracting 6.8% q/q ann. in Q2. Clear downside risk to our forecast of 3.0% q/q GDP growth in Q3.

Industrial production in July increased 0.2% m/m (consensus: 1.0% m/m) after declining 3.4% m/m in June. According to the production plans released in connection with the data, manufacturers plan to increase industrial production by 1.3% in August and 3.5% in September. Actual production tends to undershoot production plans substantially. Our forecast for industrial production in August and September based on the industrial production plans is now 0.2% m/m and 1.5% m/m respectively. Hence, industrial production will recover gradually but is now expected to contract 1.2% q/q in Q3 after contracting 6.8% q/q in Q2. Hence, industrial production at the moment points to a relatively weak recovery in Japan.

Private consumption indicators also disappointed. Seasonal adjusted retail sales in July declined 0.5% m/m after increasing 0.5% m/m in June. As seen in the chart below the overall picture remains that the recovery in retail sales after the consumption tax hike has been weak. This was also confirmed by the broader but very volatile household spending survey for July that was also substantially weaker than expected. According to this survey household spending in July contracted 5.9% y/y (consensus: 2.9% y/y) after contracting 3.0% y/y in June.

The labour market remains a ray of light in the Japanese economy, although there are signs that the improvement in the labour market is slowing (see chart below). The unemployment rate in July increased to 3.8% (consensus: 3.7%) from 3.7% in June, while the job-to-applicant ratio in July was unchanged at 1.10 in line with expectations.

The increase in CPI excl. fresh food in July was unchanged at 3.3% y/y in line with expectations. Excluding the impact from the consumption tax hike in April (the inflation measure that Bank of Japan targets), CPI excl. fresh food was also unchanged at 1.3% y/y. Overall CPI excl. fresh food and the consumption tax have declined slightly in recent months from 1.5% y/y in April. We expect this measure for inflation to continue to decline slightly in the coming months.

For Bank of Japan the implication is that it will probably soften its statement in connection with its next meeting on 4 September but is unlikely to announce any new easing measures at this meeting. In the statement next week Bank of Japan will probably acknowledge that there is downside risk from the consumption tax hike. So far Bank of Japan has refused to even acknowledge that the consumption tax hike was a major downside risk, arguing that higher wage growth would gradually offset the negative impact from the tax hike. We expect Bank of Japan to revise it growth forecast lower in connection with its meeting on 31 October. At this meeting further easing is possible.