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Japan Trying Hard

Updated views on the global economy and asset markets

Abenomics: losing momentum

Recent economic indicators suggest the “three arrows” of Japanese Prime Minster Shinzo Abe’s “Abenomics” are losing momentum. Although the upward revision of seasonally adjusted Q3 GDP growth (to 1% from -0.8%) means the economy will dodge a recession this year, private consumption growth was lowered to 0.4% (q/q) from 0.5% in the preliminary report.

A slowdown in machinery and equipment investment bodes poorly for capital formation, lowering the odds of sustaining the acceleration in Q4. Lackluster growth rates for industrial production (hovering around 0%) and exports (0.2% y/y in October in volume terms, the lowest level since August 2014) further underscore that a resilient growth recovery is not yet at hand.

Given these indicators, we have trimmed our 2015 GDP growth forecast to 0.7% (from 0.9% in September) and our 2016 estimate to 1.2% (from 1.4%). Our previous forecasts were also predicated on the Bank of Japan (BoJ) deploying more monetary stimulus in October, but the Bank instead adopted a “wait and see” stance in the hope that the economy will break free of entrenched deflation expectations in 2016.

More Monetary Easing Expected

We now expect the BoJ to step up its so-called quantitative and qualitative easing (QQE) program in April 2016 in the face of below-target core inflation and sluggish wage growth.

On the price front, nationwide core inflation (ex-fresh food) remained at -0.1% in October and the BoJ’s “core-core” inflation metric (ex-food and energy) slowed to 0.7% in October from 0.9% in September. The share of households expecting prices to rise by 2% or more over the next year declined to 34.7% in October, down from 37.5% in September. Over a five-year horizon, the 2%+ club contracted from 60.9% of households to 55.8%; both series are at their lowest points since April 2013. Inflation seems unlikely to hit the BoJ’s FY2015 forecast, even after it was downgraded to 0.1% from 0.7% at the October policy meeting.

Real wage growth looks set to remain tepid, despite Prime Minister Abe, BoJ Governor Kuroda and other officials urging companies to grant substantial pay hikes in the spring round of wage negotiations. Having pushed for a pay increase of “at least 2%” in 2015, trade unions are now seeking wage growth of “around 2%” for next year, which seems like an even weaker target. Besides, although firms committed to raise wages by 2.4% on average last spring—the highest such figure in 17 years—real and nominal wage growth came in at a mere 0.6% in H1 FY2015.

While wage, price and growth data are all likely to fall short of the BoJ’s forecasts, we note that dissenting voices could prevent an expansion of QQE. Some officials fear the program will undermine the resilience of the BoJ’s balance sheet and distort the Japanese government bond market. GDP growth and inflation will take a hit if the BoJ decides not to expand QQE in 2016.

Fiscal Consolidation to Continue

Fiscal consolidation will likely continue. But in light of the proximity of the 2016 parliamentary election, the pace of retrenchment will remain slow. Prime Minister Abe has vowed to lower the corporate income tax rate below 30% in FY2016 (from 32.1% at present).

A supplementary budget (¥3 trillion-3.5 trillion) will likely be submitted to parliament to help farmers cope with the dismantling of agriculture-sector trade barriers under the Trans-Pacific Partnership. Thus, the consumption tax hike (to 10% from 8%) will likely go through in 2017 regardless of prevailing economic conditions (as stipulated in the deal to delay the tax increase in 2014).

Given the first tax hike in April 2014 was followed by a technical recession, additional monetary accommodation would be needed (and front-loaded) to mitigate the negative impact on the already fragile economy.

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