Bank of Japan Rhetoric at Odds with Data

Economic Update

Japan’s economic recovery has wobbled with the latest figures released in September showing Japan’s GDP fell from 1.0% in the first quarter of 2015 to -0.3% in Q2. The Bank of Japan (BoJ) have remained upbeat despite the disappointing result, suggesting the economy was still enjoying a moderate recovery and there was a widening trend towards higher prices. The BoJ points to a weaker Yen as a boost of company profits, which it hopes will be reinvested, but this is not the case.

The Chinese slowdown is likely playing a part in Japan’s recent troubles, with capital spending in Japan falling -0.9% from Q1 to Q2. The slackening manufacturing side of the economy is also seen in core machinery orders which performed poorly in the quarter with August falling by -7.9% m/m and September down -3.6% m/m. Industrial production also dipped in September by -0.8% m/m, however the Manufacturing PMI remains relatively stable at 51.7.

Average Cash Earnings, a measure of wage inflation that gives a glimpse at future spending habits, came in just 0.6% higher than a year ago, well short of the 2.1% expected. In August the metric fell to -2.4% y/y, which was a shock to the market. Retail Sales have trended lower in line with the falling wage growth, falling from 5.0% y/y at the end of Q2, to 1.8% y/y currently.

Monetary policy has been a talking point throughout the quarter for the market, or more accurately, the lack of change in monetary policy. There has been widespread speculation that the BoJ will expand its Quantitative Easing programme in the face of deteriorating economic indicators. The BoJ has so far remained upbeat about the recovery, despite the figures pointing to the opposite. Perhaps they know something the rest of us don’t? Regardless, the QE programme has been maintained at ¥80t annually in an attempt to spur inflation up to the 2% target rate.

Inflation has continued to disappoint as it slips to its current level of 0.2% y/y. This headline figure includes the falling energy prices which Japan relies of for electricity generation, so other indicators need to be looked at. National core CPI has fared no better, however, falling to -0.1%. The GDP price index, which is a measure of inflation of the goods and services used in the GDP figure, is slightly more encouraging at 1.5% y/y, however, this is a lagging indicator showing Q2 inflation.

BoJ Governor Haruhiko Kuroda told parliament in September that while the recovery appeared "patchy", conditions were falling in place for inflation to hit 2 percent as more firms raise prices. He has also signalled that factors such as falling oil prices and the slowdown in China are out of the banks control, which explains why he is reluctant to expand QE.

The Yen weakened in the first half of the quarter thanks to the market’s optimism that the US Federal Reserve would raise interest rates, and the concern that the BoJ may look to increase the stimulus. It could not breach the highs found in Q2 however, and a rejection off the resistance at 125.00 was swift.

The turmoil in global markets in mid-August led to heavy demand for the safety of the Yen, with one day, Monday 24th August, seeing a 580 pip range for the day, the largest since 2010, and an overall gain of 335 pips for the Yen. Since then the USDJPY pair has consolidated around the 120.00 mark as the market awaits more clarity from both central banks.

Economic Outlook

Japan has an extremely tough quarter ahead, economically speaking. The slowdown in China is likely to see further disappointing results on the Japanese manufacturing sector. The results we have seen in the manufacturing sector and wage growth are likely to be reflected in poor GDP results for Q3. Another result in the negatives and Japan will officially be in (yet another) recession.

The Asia Development Bank recently cut their forecast growth rate from 1.1% for 2015 to just 0.7%. At the same time they reduced their outlook for China and the rest of Asia, which is a concern for Japan given the amount of trade that goes to the developing parts of Asia. The OECD has taken a more pessimistic approach, downgrading Japan’s GDP growth to 0.6% for 2015.

The Bank of Japan remains eternally optimistic in the face of the deteriorating data. After the last policy meeting in September, BoJ Governor Kuroda said “there is no change to our view that Japan’s economy continues to recover moderately”. He did concede that exports and output are being affected by the slowdown in emerging economies, but remained positive. The BoJ have growth forecast at 1.7% for the year to April 2016, which we believe is perhaps a little too optimistic.

With the outlook for inflation remaining flat, speculation will only grow as to when the BoJ will be forced to act. If QE is expanded, we are likely see it pushed up to ¥100tn per year. Governor Kuroda has reiterated “we won’t hesitate to adjust monetary policy if there’s a change in the price trend and we think (further action) is needed to swiftly achieve our price target.”

The Yen will be an interesting currency to watch in the quarter ahead. Its movements will tell you a lot about the market’s expectations of the actions of both the FED and the BoJ, and also general risk. If the Bank of Japan responds to the deteriorating economic situation with an expansion of QE, then the Yen will depreciate considerably. The 130.00 mark may be a bit of a stretch, however, if the Fed does raise interest rates by the end of the year, combined with Japanese stimulus, then anything is possible.