Japan Employment and Unemployment March 2008

Seasonally adjusted unemployment dipped to 3.8 per cent in March. While that was better than the flat result of 3.9 per cent in a consensus market forecast, economists focused instead on a fall in the ratio of job offers to job seekers. That slipped to 0.95, meaning 95 jobs were available per 100 applicants.

”The trend shows hiring is slowing for the moment especially among small businesses, while big corporations continue to recruit new employees briskly,” said Yoshiki Shinke, senior economist at Dai-ichi Life Research.

Overall household spending fell 1.6 per cent in March from a year earlier in price-adjusted real terms, countering a median market forecast for a 0.5 per cent increase and further signalling weak consumer spending.

Such weakness in the domestic economy will likely keep the BOJ concerned about downside risks in coming months. Still, like other central banks, the BOJ faces rising fuel, raw materials and food prices as it ponders what to do with rates, already at a very low 0.5 per cent. Japan’s core annual inflation rate hit a decade high of 1.2 per cent in March, and as the expectation grows that the Federal Reserve’s easing cycle is coming to an end after one more 0.25 percentage point cut last Wednesday, markets are now even pricing in the possibility of a BOJ rate hike. Swap contracts on the overnight call rate are pricing in around a 60 per cent chance of a rate hike by the end of the year.

That is a sea change from just a few weeks ago when investors had been looking for a BOJ rate cut as the credit crisis weighs on global economic growth. Still the evidence and justification for expecting any such cut is rather thin.

Housing starts, hit hard by a regulatory change last year, are hardly giving cause for great optimism since they fell 15.6 per cent in March from a year earlier, below a median market forecast for a 6.7 per cent drop.



Also, the NTC Research/Nomura/JMMA Purchasing Managers Index, which gives an early snapshot of the health of manufacturing, declined to a seasonally adjusted 48.6 in April from 49.5 in March and was the lowest since 48.1 in February 2003. A reading below 50 points to a contraction in manufacturing activity.

Japanese Household Spending March 2008

Overall household spending fell 1.6 per cent in March from a year earlier in price-adjusted real terms, countering a median market forecast for a 0.5 per cent increase and further signalling weak consumer spending. Such weakness in the domestic economy will likely keep the BOJ concerned about downside risks in coming months.



Still, like other central banks, the BOJ faces rising fuel, raw materials and food prices as it ponders what to do with rates, already at a very low 0.5 per cent.Japan’s core annual inflation rate hit a decade high of 1.2 per cent in March.



Housing starts, hit hard by a regulatory change last year continue to decline, falling 15.6 per cent in March from a year earlier.

And just to add to the gloom, NTC Research/Nomura/JMMA Purchasing Managers Index, which gives an early snapshot of the health of manufacturing, declined to a seasonally adjusted 48.6 in April from 49.5 in March and was the lowest since 48.1 in February 2003. A reading below 50 on such an index points to a contraction in manufacturing activity.

Japan Industrial Output March 2008

The Bank of Japan kept interest rates on hold as expected on today as rather gloomy industrial output, household spending and job figures pointed to weakening growth in the wake of the credit crisis. The weak data, along with a slump in U.S. consumer confidence, pushed up Japanese bond prices, amid worries that American economic woes were hitting the big exporters that are sustaining Japanese growth.



The central bank, which has its key interest rate already at a low 0.5 per cent, is expected to cut its growth outlook and raise its inflation forecast in a half-yearly economic report due out today. Japanese industrial output fell 3.1 per cent in March – the biggest monthly fall for at least five years and far below a market median forecast of a 0.8 per cent drop.

”This could raise concerns that the Japanese economy is slowing down sharply in the January-March quarter,” said Yasuhide Takahashi, economist at Nomura Securities. ”Output is also not expected to recover much in coming months after a sharp drop in March. We think the economy will remain sluggish until the third quarter of this year.”

Japan Retail Sales March 2008

Japan's retail sales rose in March as households paid more for gasoline and food, leaving them less to spend on clothing and furniture. Sales climbed 1.1 percent from a year earlier, the Trade Ministry said today in Tokyo.

Japan Consumer Price Inflation March 2008

Well inflations seems to be making all the news at the moment, even in Japan. Japan's consumer prices rose at the fastest pace in a decade in March as companies passed on higher costs of gasoline and food to protect profits. The headline core CPI rate, which includes fast-rising energy prices - but excludes fresh fruit, fish and vegetables - was up 1.2 per cent on-year the statistics bureau said in Tokyo today. Not only that, even "core-core" prices - ie prices excluding food and energy - were up for the first time, even if by the very small margin of 0.1% year on year. Of course this has got people all over the place talking, like David Pilling in the Financial Times for example:

"Japanese consumer prices, stripped of energy and fresh food, rose 0.1 per cent on-year in March, the first increase since 1998 and a sign that Japan could be close to shaking off 10 years of deflation."

(Only 10 years!! Deflation in Japan goes back to the early 1990s, and the crash of the housing bubble in 1992, but still). Doubtless Claus will come in with a fuller analysis as and when time permits, but I think we need to be very very careful here. We need to know where the Japanese economy is headed next before we draw any such rapid conclusions about whether or not Japan has finally "shaken off" deflation (take a look at the chart below).






I would find the argument a lot more plausible if we were now near the start of an expansionary cycle, rather than watching the sunset of one of the longest economic expansions cycles in recent Japanese history. As I indicated in my recent post, Japanese export growth weakened in March, the IMF and World Bank are predicting a slowdown in the rate of expansion of global trade, and we really need to get some measure of how the Japanese economy is going to weather this particular storm before we jump to any "over hasty" conclusions.

On the details, of the 1.2 per cent rise in the headline CPI, 0.73 percentage points were due to energy and 0.41 points came from food. According to research from Goldman Sachs the cost of mayonnaise was up 17.5 per cent year on year, while spaghetti rose 26.6 per cent and dairy products 3.8 per cent. Economists are now generally begining to characterise Japan’s rising prices as cost-push inflation.

Hiroko Ota, economy minister, characterised the rise as the wrong kind of inflation. “The price rises are being led by upward pressure from higher raw material costs and not by strong demand, so it is not a good pattern,” she said

Japanese government bonds tumbled following the release of the news, causing the biggest jump in five-year yields in nine years and forcing a halt in futures trading for the first time since 2002. Ten-year bond futures fell as much as 1.8 percent, causing the Tokyo Stock Exchange to suspend trading for 15 minutes. The yield on the 0.8 percent bond due March 2013 rose 19.5 basis points, the most since 1999, to 1.24 percent as of 3 p.m. in Tokyo at Japan Bond Trading Co., the nation's largest interdealer debt broker. The price fell 0.887 yen to 97.973 yen. The yield is at the highest level since October 2007. Ten-year bond futures for June delivery lost 1.49 to 135.59 as of the close of trade. Yields on 10-year bonds increased 12 basis points to 1.6 percent, the highest since Nov. 2.


What is causing all this movement is some quick switching of bets on the most likely direction of the next move in BoJ set interest rates. Governor Masaaki Shirakawa and his colleagues will are now deemed to be more likely to stick to their policy of gradually increasing borrowing costs in their twice-yearly outlook next week. As a result investors now see a 66 percent chance of a rate increase by December compared with 38 percent before today's report, according to JPMorgan Chase & Co. calculations. As recently as March 20, traders were pricing-in a 71 percent likelihood of a cut. Whether they will raise or whether they will cut depends on a lot more than the monthly reading on the CPI (IMHO), and I think Claus's poposed measures of investment in machinery and equipment and export performance will offer us a much better guide of the future evolution of policy.

The central bank is faced with a complex set of calculations. The rising headline rate might, in some circumstances, lead it to consider a rate rise. But the difficult international situation in financial markets coupled with the low rate of the so-called “core-core inflation”, excluding energy and food, means it is far more likely to leave rates where they are at 0.5 per cent. If the economy deteriorates, bank watchers are not excluding the possibility of a rate cut.
David Pilling

Japanese Exports March 2008

Well Japan's "indian summer" of growth may well be drawing to a close as the slowing rate of increase in world trade gradually takes its toll. Japan's exports rose in March at the slowest pace in almost three years as shipments to Asia - which had been giving some additional impetus - lost momentum while the impact on U.S. exports of the slowdown there continued to bite. Exports, which were responsible for more than half the economy's fourth- quarter expansion, rose 2.3 percent from a year earlier, the Finance Ministry said today in Tokyo.





Japanese exports to the United States recorded recorded their biggest year on year drop in more than four years in March and shipments to Asia and Europe slowed, signalling the downturn which started in the United States may be gradually spreading throughout the global economy.

That would spell trouble for Japan’s export-reliant economy, where growth is already stalling, although the trade data did little to alter the prevailing market view that the Bank of Japan (BOJ) will leave monetary policy unchanged this year.

Underscoring U.S. recession fears, Wednesday’s data showed that exports to the United States fell 11.0 per cent compared with March last year, the biggest drop since November 2003, due to slack sales of Japanese cars.

Exports to Asia and China rose, but by the smallest percentages since mid-2005, casting doubt on the view that emerging economies will enjoy strong growth despite the U.S. problems.


Swap contracts on the overnight call rate are no longer pricing in any chance of a BOJ rate cut from the current 0.5 per cent by the end of the year. In fact, they point to the risk of a rate increase early next year. But some analysts say investors are going too far in shifting their focus to rate rises, especially with media reports saying the BOJ will more than likely downgrade its growth forecast in an upcoming review of its policy framework.



Especially noteworhy was the drop in Japan’s trade surplus, which fell 30.2 per cent in March from a year earlier to 1.119 trillion yen ($10.88bn).




Exports to Asia rose 1.9 per cent in March from a year earlier, a steep fall from the 13.8 per cent logged in February. That was mostly due to a sharp slowdown in exports to China, with growth of 3.2 per cent in March after 14.8 per cent in February.

Japanese semiconductor exports to Asia fell 18.6 per cent in March, reflecting sharp declines in chip prices due to a supply glut and lower demand for personal computers.

The only significant countries to increase their annual rates of purchases of Japanese products were Russia (up 54.5%) and Chile (up 107.9% but from a very low base). Brazil (up 33.7%), Indonesia (up 20.8%), India (up 19.7%) and Vietnam (up 38%) all maintained strong growth trends, even if the rate of increase fell back in each case from February.

Japan Consumer Confidence March 2008

Well, Japan's consumer confidence ticked back up ever so slightly again in March, but as you can see from the chart, this is really nothing to write home about.




Japan's consumer confidence rose from February's five-year low in March after households said they were more optimistic about job prospects. The sentiment index climbed to 36.7 last from 36.1 in February, the Cabinet Office said today in Tokyo.

The gain in confidence is unlikely to be sufficeient to spur consumer spending as stocks fall, oil and food prices rise and risks increase for a slowdown in global trade.

In fact world trade growth declined sharply in 2007 and is expected to slow further this year as financial turmoil and rising commodity prices further depress global economic activity, according to a report from the World Trade Organisation out today. Preliminary estimates suggest the volume of world trade rose 5.5 per cent in 2007, down from a robust 8.5 per cent in 2006. Based on the latest gloomy global output forecasts by the International Monetary Fund, the WTO says trade growth this year could slip to 4.5 per cent, its lowest rate since 2002.

At the same time Japanese consumers are increasingly strapped for cash as inflation in basic lifestyle items outpaces growth in their paychecks. And households are becoming increasingly concerned about prices, with some 42.3 percent of the people interviewed who felt conditions are worsening citing prices as a reason, more than double the share of a year ago. Today's report also showed that 86 percent of consumers expect prices to keep rising.

Japan Machinery Orders February 2008

Japanese machinery orders fell in February after accelerating at the fastest pace in seven years January. Equipment orders, which give an indication of capital spending levels over the next three to six months, declined 12.7 percent from January, when they climbed 19.6 percent, the Cabinet Office said today in Tokyo.




Perhaps it is just worth taking a look at the cabinet office charts on the evolution of orders at this point, since while the rate of increase fell back in February orders were running at a truly high level in January, so as compared with November and December of 2007 the situation is not really all that bad.

Japan Economy Watchers Index March 2008

Sentiment among Japanese merchants bounced back slightly to its highest level in four-months in March. The Economy Watchers index, a survey of barbers, taxi drivers and others who deal directly with consumers, rose to 36.9 from 33.6 in February, the Cabinet Office said today in Tokyo. Meanwhile the outlook index of conditions in two to three months fell to 38.2.



Basically I think this is consistent with a lot of other data we have been seeing of late which suggests that the resilience in the export sector - driven largely by stronger than anticipated growth in some other Asian economies - is holding Japan back from falling into recession at the moment. As Claus noted yesterday, Japan's leading index, which is a composite derived from 12 indicators including housing starts and stock prices, also rose in February (to the 50% mark), just reaching the threshold that indicates growth rather than contraction over the next two quarters, according to the Cabinet Office yesterday. The index has been below 50 in eight of the past 12 months.





As such conditions continue fluctuate, and the Japanese economy continues to eke out growth, but it is very hard to see how long this new found lease of life will last, and it is also important to note that while these indicators are bouncing back, they are normally bouncing back from what have been very low levels.

In this context it is perhaps worth noting the striking parallel which exists between what is currently happening in Japan and what is happening in that other important export driven economy - Germany. German growth is more or less holding up at the present time, thanks again to stronger than expected export growth to emerging markets, this time in Central and Eastern Europe. And all of this is taking place as credit conditions tighten across the OECD economies and funds flood out in search of higher yields in some of the planets most rapidly growing economies, and of course as these economies then need to import from countries like Japan and Germany to feed their investment projects.

2008 OECD Survey of Japan

Today we learned, if anything, that Japan is indeed balancing on the knife's edge of a recession. With the leading economic index clocking in a score of 50 which is right in the bulls eye between expansion (>50) and contraction (<50). For more on the cyclical assessment I am referring to my most recent write up here as well as the numerous analytical posts Edward has made in the context of concrete data releases.

As such, today's most important release on Japan is without a doubt OECD's 2008 Survey of the Japanese economy and society. For most of you I guess that the whole publication won't be available but from the chapter-wise summaries you should be able to get a good picture. In many ways, the OECD's recommendations and calls for action are very much standard stuff. However, there was specifically one thing which caught my eye as I read it in Bloomberg's small review of the publication.

Japan's central bank should avoid raising interest rates until inflation is ``firmly positive,'' the Organization for Economic Cooperation and Development said. ``Further hikes would not be warranted until inflation is firmly positive and the risk of renewed deflation is negligible, hence avoiding the risk of derailing the expansion,'' the OECD said in its report on Japan's economy released today.

I think this is rather important since it highlights the need, as we also here at JEW have been relentlessly arguing, to treat the current inflation dynamics in Japan with care in connection to the application of standard economic theories. Japan is still formally in deflation if you strip out energy and food and the fact that this price gauge has not risen in the last decade is not to be taken lightly. Moreover, Japan also suffers from asset price deflation (or very close to it) in key pockets of the economy something which all those reports on downtown Tokyo real estate tend to neatly bypass. As a backdrop of this the OECD recommendation to hold off raising interest rates until inflation lingers may prove to be somewhat of an eternal waiting game. The OECD also spends a large part of its ammunition to discuss Japan's appalling fiscal profile and its public debt. Coupled with a relentless process of ageing this is by far the most serious challenge for Japan. The OECD thus moves into the proverbial mindfield by suggesting that Japan not only curbs public spending but also widens the revenue base by instigating those much debating consumption taxes. The immediate impetus for these suggestions are straight forward. Simple extrapolation of Japan's y-o-y fiscal position as well as its monumental debt to GDP ratio of 180% point to a wholly unsustainable outcome if action is not taken. However, such measures will not come without costs. As we have persistently been showing here at this space the endemic nature of Japan's consumption and the subsequent reliance on exports to grow cannot be detached from the demographic realities. In this way, there is a risk that Japan's current growth path would be even further solidified by raising revenue from an already beaten down consumers. However, where to raise those revenues then? This is indeed the vexing question; given the fact that growth is now coming mainly from exports and income earned from foreign assets it would perhaps be wise to also look here to balance the effect from raising revenues. However, I also realize that this will be difficult to square in absolute terms since the revenue base from taxing consumption is much higher and therefore may be difficult to avoid. Precedence for this can be seen in Germany where indirect taxes in the form of VAT were raised recently.

Yet, I won't rant at the OECD here since I do think that they manage to pinpoint the main issues. One thing however that I would like to see is simply more focus on the problem at hand with respect to the chaning demographics of Japan. As such it is not that OECD is not aware of the issue itself; not at all. But I would like to see much more explicit focus on how to raise fertility because at the end of the day, and even though the effect won't be seen for the next generations, this is ultimately what is needed in Japan's current situation now that we are talking about long term structural tendencies.

(Un)steady as She Goes in Japan

Last time I had a look at the economic state of play in Japan I asked the rhetorical question of whether Japan was resisting the signs and claims that she is heading towards a recession. Upbeat signs from household spending and a smaller than expected revision of Q4 GDP suggested that this might be the case. In my note however I reiterated my general discourse on Japan in which I have argued since the latter part of 2007 that Japan was now heading for a significant slowdown. The recent data from February seem to confirm my analysis. As per usual Edward has already been moving in with snippets on Japan Economy Watch regarding the latest data on inflation and unemployment, exports, and industrial production. In this note I will deal with the trend in domestic consumption, prices, and also corporate capex proxied by industry activity and industrial production. Especially this latter data point is a key gauge for the assessment of the Japanese business cycle. On top of the real economic data the Yen continues to linger in a territory which is likely to cause more than a few raised eyebrows amongst Japanese business leaders and the political situation is beginning to resemble more and more of battle of wills between the leading party the LPD and the opposition the DPJ. As you can see we have a lot of ground to cover and as such let us commence.

If we begin with the analysis on prices the situation is basically a copy-paste from my previous analyses. The trend thus lingers with the main inflation index posting an increase in the rate of increase whereas the core-of-core index excluding food and energy is still stuck in deflation.

In my last note I reiterated the general point that this divergence needs to be explained by the fact that Japan is subjected to cost-push inflation rather than demand-pull inflation. The general tendency in domestic demand relative to a buoyant external sector seems to underpin this point. For more on this I invite you to go back to my most recent note which is linked above in which I provide charts of import prices and secondary wholesale inflation. The message to extract seems to be consistent with the main inflation picture derived from the graph above. Especially energy imports have risen in price recently and this trend is confirmed by looking at the corporate price index (wholesale inflation) where the main index is flat with a rising tendency whereas energy inputs is up significantly. In general, the inelasticity between increasing inflation throughout the value chain and inflation stripped from energy (and food) underpins the current inflation dynamics observed in Japan. If we turn to consumer spending I noted last time how the Japan statistical office had added a couple of new time series to their arsenal. Below I field one of them which plots y-o-y increase (monthly data) in consumption expenditures adjusted by the number of workers in the household.

The first graph plots the headline data reported in the general media. As can be seen the end of 2007 as well as the beginning of 2008 have seen some significant spikes which provides for an overall rather positive last couple of months. The most recent data however show that household spending was flat (0.0% increase) in February and given the underlying confidence indicators which have been all down I don't see how we can expect the Japanese consumers to power ahead in the immediate future. Basically, the Japanese consumer is now in a double pinch as are many other consumers around the world. Real economic activity is decidedly headed down but inflation remains stubbornly high and even on the rise. Moreover and given the fact that inflation is coming mainly from primary goods such as energy and food (i.e. for which demand elasticity is low) it leaves consumers with less income for other goods. This 'stagflation lite' scenario is especially significant in Japan's case where income is flat to declining. This specific set of dynamics might also explain why the increase in consumption expenditures seem to be deviating from the general business cycle indicators since there might be a value component pushing up the number as consumers cannot but take on the full load of price increases in food and energy. This point seem to be anecdotally confirmed if we turn to Ken Worsley and his ardent watching of Japanese supermarket sales. As Ken succinctly puts it ...

What do these [the] numbers tell us? We’ve been noting for some time now that supermarkets have actually been doing well on the sales of food. In other words, core business has not been so bad. Sales of household products, clothing and services, however, have been dragging the overall figures down month after month. (...) Selling more food as a proportion of the whole thus seems to bring about better overall sales. We are forced to wonder if food sales are increasing due to the price increases or because supermarkets are making an effort to focus on core operations.

This is all very difficult to say really but it may definitely cloud the picture. The last two graphs need little interpretation and are presented as a way to anchor the cyclical analysis by showing the monthly developments in the context of a general trend. It is thus pretty clear that the general trend for growth in consumption expenditures is inexorably down. The key I think will be the extent to which current slowdown will tilt down the trend line if at all. The uncertainties surrounding the interpretation of the consumption indicators for cyclical purposes highlight why would be well advised to look elsewhere for a solid indicator for the immediate outlook in Japan.

Traditionally industrial production and corporate capex have shown themselves to be solid indicators. As Edward showed us a couple of days ago industrial production dropped for the second consecutive month in February as manufactures are now clearly cutting back on production. Japanese production was very strong in the latter part of 2007 and it seems as if we are now, at least, going to see a reversion to the trend from the first part of 2007. Economic sense would also suggest that a backdrop was in the cards as activity is now visibly slowing. However, a more detailed analysis of stocks and inventory flows would be needed in order to weigh in on this point. As ever, the external position is also important in this context. Recently we learned that exports continued to grow briskly in February and more importantly that Japan seems to be well diversified in order to shug off a US slowdown even if of course a knock-on effect is inevitable. As long as external demand remains strong so will, to some extent, corporate capex. However, the global economic edifice is slowing and in particular economies with external deficits on which Japan naturally depends seem to be in the front line of the slowdown. In this light the chart below which plots a longer time series of industrial activity and industrial production might aid us;

As can be seen Japan has experienced a steady increase in industrial production since the end of 2001 which represents the trough of the last recession in Japan. Whether this line is now set to decline as part of a textbook wave-like cyclical pattern is obviously impossible to say. However, given the lengthy and messy nature of Japanese recessions in recent years and the long expansion we have up until now this figure will be interesting to follow as we move forward. Adding to the overall picture today's release of the Tankan survey (see short summary here) for large manufacturers furthermore solidifies the outlook. In numbers, the manufacturing index fell from 19 in Q4 2007 to 11 in Q1 2008 as well as the outlook measured as a forward looking sentiment gauge also declined substantially. In summary I think it is fair to say that if we look at the main cyclical indicator in the form of industrial production and corporate capex we are confirming the general market discourse at this point that Japan is headed for a significant slowdown and perhaps even a recession.

Another theme I have been including in my analysis on Japan consist of an ardent look at the Yen which, in connection to a widespread unwinding of carry trade, has appreciated significantly since the credit turmoil began. Recently, I made a longer analysis of the structural drivers of the Yen (proxied by the USD/JPY) in the context of unwinding carry trade in which I fielded a graph of the JPY's ascent since the financial crisis began. Below I extent this figure with the latest observations;

Note that down means up in this graph for the JPY as the graph shows indirect quotes. As we can see Q1 2008, which we are ending today, saw a sharp appreciation of the JPY in particular against the GBP and USD. This reflects two things. On the one hand there is definitely an interest differential story but more importantly I think is the general tendency for the JPY to be driven by the general market risk sentiment. Most recently the JPY has receded a bit but the trend is still clear. As I have said it remains to be seen what will happen if the BOJ moves in with a cut in Q2. We should expect the JPY to depreciate on such events but given the fact that the Fed and BOE may still have some cutting to do (especially the BOE) it is not clear where to put your money. I am still looking for fundamentals to reign in the JPY's rise but the time is not yet ripe to paraphrase Morgan Stanley's Stephen Jen. Moreover, I still hold that the ECB will blink during the course of 2008 (I still have Q2 pencilled in but that call is beginning to look dubious); this could potentially spell a roller coaster for the EUR/JPY since this pair is trading at relatively high levels in a more long term context.

A final theme I have been, more or less, forced into is the dirty subject of Japanese politics. Normally I would not venture much analysis on this topic but recently events in the political edifice have been so intertwined with economic factors that it has been impossible to neglect. As I hinted in my introduction the situation is now one of a stalemate between the ruling party LDP with the majority in the lower house and the DPJ controlling the upper house of the Diet. As we have seen recently this has produced some rather spectacular skirmishes on the political scene. Perhaps the most enticing was the flurry surrounding the nomination of the new BOJ governor which almost turned into a farce as the LDP continued to nominate candidates with close ties to the Finance ministry something which the DPJ had specifically said it would not accept. The main economic risk from this debacle in an immediate context was (and is) the extent to which Finance ministry officials would move, temporarily or more permanently, closer to the decision making at the BOJ. This would consequently increase the risk of intervention to quell the flight of the JPY and a rate cut to come sooner rather than later. More to the point the main impact of this will of course be the extent to which we are now faced with a crippled political system in a time where Japan needs anything but and as the Economist noted recently the cleansing process has not even begun ...

So Japan remains stranded unhappily between the one-party state it once was, under a dominant LDP, and the truly competitive democracy it might one day become. Some politicians have mused about the possibility of a political upheaval after the next election, in which the main parties would collapse under their internal strains and regroup.

Looking forward and thus in case you did not think the BOJ spectacle was enough a number of budget related bills expired yesterday as the fiscal year in Japan ended. Once again, as Takehiro Sato explains in detail, the opposition is eyeing a possibility to pinch the LDP by allowing these bills to expire. The specific niggle about these legislative snippets which include among other things a gasoline tax is of course that they have to be ratified in both chambers of the Diet. As could have been expected Fukuda is now warning over the potential hole in the budget arising from the opposition's decision to let the bills expire;

Yasuo Fukuda warned on Monday that Japan faced a budgetary crisis after the opposition forced the withdrawal of a petrol tax, depriving the government of Y2,600bn ($26bn) in revenue, equivalent to 1 per cent of gross domestic product. Japan’s prime minister said the expiration of the tax on Tuesday would produce a “gaping hole” in the Y83,000bn budget, forcing his administration to consider cuts to social welfare programmes or issue deficit-funding bonds.

As can consequently be seen the political upheaval continues in Japan and at this point the potential for a general election is clearly there. As for concrete consequences Sato makes the timely point that consumers may well have held back on energy consumption at the end of March in expectation of the bill's expiration just as they may hoard petrol once the bill is re-instated. This is likely to happen towards the end of April.

In Conclusion

Since last time we convened to look at Japan the tide of the data has not turned much. The message from the inflation front is still one of cost-push rather than demand-pull inflation. At this point in time inflation is not finding its way to consumers in the context of durable goods and services. However, the steady increases in energy and food is another matter and here the Japanese domestic situation is beginning to resemble a situation of stagflation. In this light, the relatively upbeat trend derived from consumer spending is surprising. It is important to note here though that there may be a value effect in play here as the increasing value component of food and energy for which demand elasticity is low show up disproportionally in the statistics. Anecdotal evidence from a breakdown of supermarket sales underpin this. Turning to a more solid indicator for the Japanese business cycle the message derived from corporate capex in the form of the recent Tankan Survey and industrial production is quite clear. Japan is now headed for a slowdown. Exports and thus external demand may as ever be a dark horse here. Recent figures suggest that Japan continues to leverage global demand most effectively to its advantage. This could put a floor under the drop in corporate capex. In the light of the cyclical outlook above I still see the BOJ moving in with a cut in Q2 2008.

In the context of the two additional themes I have included above both the JPY's recent appreciation and the political quagmire provide for several dark clouds over the Japanese economic edifice. As always when it comes to currencies the sentiment has a tendency to be rather elastic once the markets settle down. In this light the probability for unilateral intervention in the USD/JPY now seems to have abated somewhat. As for the political situation the system is currently limping. As the LDP and DPJ continue their dance macabre external investor confidence is likely to come under pressure as well as domestic confidence in politicians' ability to handle affairs is sure to wane. The potential hole in the coming year's budget is furthermore troubling. Japan has a distinct interest in keeping its growing public debt as a far out of the spotlight of international rating agencies as possible. The current debacle may make this difficult especially if Fukuda resorts to the knee-jerk reaction and issue bonds to cover the short fall.

Tankan Index Hits Four Year Low

Just to follow up briefly on yesterday's post, the results of the latest Tankan index of manufacturer sentiment is now out, and it shows that confidence among major Japanese manufacturers fell to its lowest level in more than four years as the plunging dollar in this quarter. The closely watched quarterly central bank "tankan" survey, released this morning, showed a fallll to 11, eight points lower than the 19 registered in last December's survey and the lowest score since December 2003.

The figure is a composite representing the percentage of companies saying business conditions are good less those saying conditions are unfavorable. Of particular significance the tankan found Japanese companies plan to significantly reduce capital expenditures in the coming fiscal year. Since the Japanese economy is largely driven by export sales and the capital expenditure necessary to back them up this is not good news.