Japan faced an unexpected downturn at the close of last year, resulting in a recession and relinquishing its position as the world’s third-largest economy to Germany. This development has sparked uncertainties about the timeline for the central bank to depart from its decade-long ultra-loose monetary policy.
Analysts caution of potential further contraction in the current quarter, citing weak demand in China, sluggish consumption, and production disruptions at a unit of Toyota Motor Corp as indicators of a challenging path to economic recovery and policy decisions.
Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute, highlighted the concerning sluggishness in consumption and capital expenditure, which are crucial components of domestic demand. He expressed that the economy lacks momentum, lacking key drivers for growth.
Japan’s gross domestic product (GDP) fell by an annualized 0.4% in the October-December period, following a 3.3% decline in the previous quarter, defying market expectations for a 1.4% increase. Two consecutive quarters of contraction meet the technical definition of a recession.
Although many analysts anticipate the Bank of Japan (BOJ) to gradually phase out its extensive monetary stimulus this year, the weak economic data may challenge its forecast of rising wages supporting consumption and maintaining inflation around its 2% target.
Stephan Angrick, senior economist at Moody’s Analytics, remarked that the consecutive declines in GDP and domestic demand pose challenges, making it difficult for the central bank to justify interest rate hikes.
Yoshitaka Shindo, Economy minister, emphasized the necessity of robust wage growth to bolster consumption, which he noted is hindered by rising prices. He mentioned the BOJ’s comprehensive evaluation of various economic indicators in guiding monetary policy.
Following the release of the data, the yen remained steady, hovering near a three-month low against the dollar. Yields on Japanese government bonds declined as some traders delayed expectations of an early BOJ policy shift.
Weak domestic demand presents hurdles for the BOJ in transitioning towards monetary tightening, noted Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities. She highlighted the increased challenge in ending negative rates, suggesting a higher hurdle for policy changes in March.
Despite expectations for robust capital expenditure, actual investment faces delays due to rising raw material costs and labor shortages, casting doubt on the BOJ’s optimistic view of investment underpinning economic growth.
While there are speculations about the timing of ending negative rates, the BOJ is likely to proceed cautiously with policy adjustments, given the lingering risks in the global economic landscape.
