BoJ unmoved as volatile data spark mood swings

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Japan’s economy appears to have passed through a mid-year storm. Gross domestic product grew at a faster than expected 2.6 per cent annualised pace in the third quarter, government data showed on Tuesday, reversing a 1.6 per cent contraction in the previous three months.

The expansion came in spite of a plunge in new building construction, making it all the more impressive and helping ease concerns that Japan’s five-year economic recovery could be coming apart. Such worries had been fuelled by a deteriorating global outlook, a surging yen and growth in Japan’s unemployment rolls.

GDP data are volatile and economists say some of the contrast between the second and third quarters was probably an illusion. The finance ministry’s corporate investment survey probably undercounted capital spending in April-June, when it showed a 2.1 per cent quarter-on-quarter fall, and exaggerated the subsequent rebound.

The Bank of Japan, which left interest rates unchanged at 0.5 per cent for the ninth month in a row, has stuck doggedly to its “central scenario” that the economy will continue to grow moderately. That is partly predicated on the as yet unrealised assumption that wages will eventually pick up. The BoJ has acknowledged, however, that risks to Japan, principally from a slowing US economy and rising oil prices, have increased in recent months.

Teizo Taya, special counsellor to Daiwa Institute of Research, says that in spite of all the ups and downs, the economy has basically been growing at a real 2 per cent for the past three to four years. Mikihiro Matsuoka, chief economist at Deutsche Bank, points to the choppiness of data and says that conditions will worsen again before they get better. He predicts a 0.6 per cent quarter-on-quarter fall in GDP in the present three-month period to December. That puts him at the pessimistic end of the scale, but other economists agree growth is likely to stick below the long-term annual trend rate of about 2 per cent until the middle of next year.

Takashi Omori, chief economist at UBS, says: “In terms of global comparisons I’m optimistic because Japan has not been affected by the subprime mortgage problem as much as other countries. But I still expect a slowdown.”

The growth in July-September was driven by exports, particularly to countries outside the US, traditionally Japan’s most important trading partner but now second fiddle to Asia. It is the US outlook that still preoccupies Japan economists, however, since a sharp slowdown or recession there would knock the broader global economy too. Mr Taya says there has been no slowdown in US consumption yet in spite of housing mortgage problems. “We have no experience yet of a slowdown in US consumption. Then we’ll see whether this decoupling theory is correct,” he says, referring to a view that Japan can weather a US downturn by exporting more to Asia and Europe.

“Asian demand depends in the medium term on income expectations in those countries, which in turn depends on their exports to the US,” Mr Omori says. UBS puts the likelihood of a US recession next year at 45 per cent.

Mamoru Yamazaki, chief economist at Royal Bank of Scotland in Tokyo, says external risks have increased, though he still counts them as “very small”. He is most concerned about rising oil and commodity prices, which he believes could hurt Japanese corporate profits and through them wages and already faltering consumer confidence.

On the domestic front, Japan’s economy has been rattled by a 40-odd per cent drop in new housing starts since building safety rules were tightened in June. Builders must now submit to a longer approval process, including review of building plans by an independent committee, but a lack of assessors has created a backlog of tens of thousands of applications. The mess was responsible for a 7.8 per cent fall in the housing investment component of GDP last quarter and many economists think the current quarter will be worse.

Consumer spending has been weak owing to stagnant wages and a rise in unemployment since the summer. Economists are divided about why wages have not grown. Some cite temporary demographic changes linked to the retirement of highly paid baby boomers, while others point to more entrenched problems at the small companies that employ 60-70 per cent of Japanese workers.

Prospects for a revival of wage growth depend partly on which camp is right, but either way external demand is likely to be key for some time to come – a fact that explains growing fears about the rising yen.

The Japanese currency has gained 6 per cent against the dollar since mid-October, raising the prospect that big exporters such as Toyota and Canon will see their profits cramped in local currency terms. Most companies have budgeted on the assumption that the dollar will trade at Y114-Y115 this year, compared with a current level of Y111.

“Manufacturing companies have been making efforts to balance yen revenues and yen expenses so the impact is smaller than it would have been even three years ago,” Mr Murashima says. “Still, the short-term impact on corporate profits will be meaningful.”

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