Standing Fast in Japan

by Claus Vistesen

eing a BOJ watcher can indeed be a tough job in terms of forecasting but sometimes it is also pretty easy. Consequently, the BOJ chose today, pretty much as expected, to hold rates steady on the back of a return of deflation in the recent months and also I guess on the back of the outlook that deflation will persist in Q1 07 and perhaps even well into Q2 07 as well. Also of course the slowdown in the US which after all is Japan's biggest export market.

The Bank of Japan kept interest rates unchanged for a second month after consumer prices fell and recent data signaled U.S. economic growth may slow.

Governor Toshihiko Fukui and his policy board colleagues voted unanimously to hold the key overnight lending rate at 0.5 percent, the lowest among major economies, the bank said in a statement today in Tokyo. The decision was expected by all 49 economists surveyed by Bloomberg News.

Fukui later told reporters that the U.S. economy will achieve a soft landing and Japan's consumer prices will rise in the long run after hovering around zero percent in coming months. Confidence among Japan's largest manufacturers slipped from a two-year high on concern a U.S. slowdown may hurt exports, the central bank's quarterly Tankan business survey showed last week.

``There's still a pretty big chance for a rate hike later this year if the central bank can confirm Japan's growth is supported by demand at home, even if the U.S. economy deteriorates,'' said Ryutaro Kono, chief economist at BNP Paribas Securities Japan Ltd. ``We expect the bank to act in the fourth quarter.''

For more on the outlook on the Japanese economy you can check out my recent notes which also dicusses in more detail the outlook in deflation based on recent analysis by Takehiro Sato from Morgan Stanley. More interestingly, we have consumer spending which indeed has shown positive signs as of late and most likely will show a healthy growth clip y-o-y in %. However, remember still that 2006 was a below trend year in terms of consumption expenditure and that consumption expenditure is still below 100 on a real Index 100 (2005) basis. In fact the trend since 2000 is one of secular decline as shown in the figure below.

This of course does not mean that this might not signify a significant pick-up but my main worry is that deflation will entrench itself in Q2 of 2007 which could feed into expectations and since Japanese consumers already are saving a lot the pick-up in consumption expenditure will perhaps be shortlived. For sure, the chance of a y-o-y improvement is there but I do not see a change in the overall trend. Finally and on deflation I leave you with a chart plotting real GDP growth and the evolution of the GDP deflation since 2001. As you can see real GDP has picked up as of late but of course so has a the Japanese trade surplus.

On a very last note I am not chaning my main position here and the outlook on deflation still worries me most although of course the recent pickup in consumption expenditure is most welcome. In terms of interest rate decisions we should expect the G7 ministers and other high lords to pounce on Japan again come next weekend although I expect that the criticism will be less pronounced than last time. I do expect however that European G7 members and officials in particular will spend time on the Yen. However, I do not see the BOJ raising on this side of Q3 with the current outlook in deflation.

Update on Wednesday, April 11, 2007 at 03:55PM by CV

The recent data on manufacturing orders in Japan actually seems to require a revision to the downside of my call on capex spending in Japan in Q1 2007. Consequently, machine orders fell 5.2% in February which clearly suggest that exports are losing steam going into 2007 and since the US after all is the biggest export market (22%) then this might be a sign of a transmission mechanism in the works (de-coupling anyone :)?). This also means that industrial production most likely will have continued its decline in March and April on two accounts Firstly, as a result of de-stocking on the back of high capex in Q4 2006 and secondly, as a result of a real decline in foreign capacity proxied by a US slowdown and perhaps also a cooling in Chinese investment.

A second data piece on Japan which caught my eye was the news that corporate credit growth supplied by Japanese banks fell in March. The decline was, it needs to be said, ever so slight and corporate credit is still growing albeit more slowly it seems. This is of course likely to be a derivative of the points above and an indication that capex in Japan is slowing on an overall basis in the beginning of 2007.

Kazumasa Iwata: the Current State of the Japanese Economy

by Claus Vistesen

have been pretty preoccupied as of late with Japan and as such I thought I would also share with you a recent speech by Deputy governor of the Bank of Japan Kazumasa Iwata on the immediate outlook of the Japanese economy and monetary policy. As you can see he is much more optimistic on the rebound of inflation and consumer spending than I am. Moreover the speech also gives a valuable insight into the policy setting process within the BOJ. Here is an excerpt from mr. Iwata's remarks on consumer prices ...

The year-on-year rate of change in the CPI (excluding fresh food) was flat in January, and depending on developments in crude oil prices and foreign exchange rates, it may turn slightly negative in the short term. From a longer-term perspective, however, consumer prices are expected, over time, to display trend increases given that the economy has expanded at an annual rate of around 2 percent over the last four years and that the expansion is expected to be long-lasting. With the continuing economic expansion, the utilization rates of production capacity and of labor have been rising steadily, and they are expected to increase further. As the recent Tankan (Short-Term Economic Survey of Enterprises in Japan) indicates, corporate managers are increasingly feeling shortages of production capacity and labor, while a positive output gap suggests that demand currently exceeds supply in the economy as a whole.

Note, especially the idea of a positive output gap and how demand exceeds supply in the economy. Methinks that someone is not taking into account the nature of Japanese growth and the relationship between domestic capex and foreign capacity. In short; how do we measure output gaps adequately in an ageing economy such as Japan's or more specifically ... how does ageing affects the operationalization of output gaps? In terms of output gaps Mark Thoma recently pointed to an article from the Dallas Fed by Mark A. Wynne and Genevieve R. Solomon. The article is an excellent intro to the economic operationalization and measurement of output gaps. Of course I have my mandatory adjustments in order to better take into account the fundamentals of ageing but all in all still a very readable article.

Following Up on Japan

by Claus Vistesen

A week ago I had a note on the economic outlook on Japan and now, with the recent data, I think it is time to do a whee round up. First of all, the chance (or risk) for an additional hike by the BOJ seems to have dissipated with the recent inflation data showing a -0.1% (overall consumer prices -0.2%) y-o-y drop in February on the back of a steady (0%) inflation rate in January. The decline was of course widely expected due to the y-o-y deflationary impact from falling energy prices but still it comes at a bad time for the BOJ after having pushed a rate on the basis of Q4 06 GDP figures and general international pressure to normalize interest rates and thus curb the carry trade. Moreover the preliminary data for March also suggest that prices declined -0.1% in. On a brighter spot industrial production 'only' declined 0.2% in February which suggests that Japanese companies won't sustain de-stocking from Q4 06 too much into March and perhaps capex will begin ticking up already in March which again depends on the fundamentals in Japan's major export markets.

On a much more positive note household spending increased 1.3% on a year earlier in February which indeed is good news as this figure is a key indicator for the sustainability and trajectory of the Japanese economy. Moreover, retail sales also showed slight positive signs although they were virtually flat y-o-y.

So, both good and bad news then but does it change anything from what I said in my last note? Firstly, let us look a bit closer on the outlook for inflation where the always excellent Takehiro Sato serves up the cold facts in a recent note over at MS GEF. The first thing to note is that deflation measured by the core index almost certainly will linger into March as I also noted above but more importantly Sato rolls out an argument and calculations which suggest that deflation will persist on a y-o-y basis much further into 2007 which effectively will stall the normalization process at 0.5%. As such, Sato notes the much pessimistic forecast of a 0.3% drop in the CPI index in Q1 2007 which may even be on the upside. In short, this smells rasther nastily of entrenched deflation in the first two quarters of 2007 save for a major hike in energy prices which are after all trending upwards at the moment. Secondly, we have private consumption and retail sales which show promising signs of a y-o-y improvement in Q1 but what about the fundamentals and the looming entrenchment of deflation? Most notably, the recent Tankan Survey (sorry, no link) also shows that consumer expectations of price increases have fallen back considerably which indicates that consumers probably will hold back spending. This is of course difficult to say and indeed the immediate outlook on demographics reveal that a lot retirees will be up for bonuses soon which means that consumer spending as a function of dissavings might be a trend to look out for but at the end of the if deflation sets in with its nasty grip the fundamentals will indeed be tested. Of course monetary policy is the last part of the equation and here I really do not think we should expect much of a hike although of course the G-7 ministers are still wandering around in wonderland poised to strike once again on the low Yen and the need for the BOJ to normalize.

In summary, I think that the recent signs from the internal demand side proxied by household spending are positive but I am truly worried and not at all happy about the outlook on in(de)flation which I fear will feed strongly into expectations and thus also consumer spending in Q2 2007.

Standing Fast

by Claus Vistesen

Hardly any economist or analyst battered an eyelid when the BOJ chose yesterday to hold the main interest rate at 0.5%. Indeed much of the recent data coming out Japan (and here) recently point to considerable risk of Japan slipping into deflation in 2007 and on that note most economists (including yours truly) expect the BOJ to be in a holding mode for the time being especially as the US economy is to slow down further into 2007.

(from Bloomberg)

Japan's central bank kept interest rates unchanged as consumer prices threaten to drop, making it hard to justify a second consecutive increase.

Governor Toshihiko Fukui and his policy board voted unanimously to keep the key overnight lending rate at 0.5 percent, the lowest among major economies, the Bank of Japan said in a statement today in Tokyo. The bank doubled the rate last month.

``The Bank of Japan probably wants to monitor the effect of the February rate hike,'' said Mamoru Yamazaki, chief Japan economist at RBS Securities Japan Ltd. in Tokyo.

Political pressure ahead of an election in July will also make it difficult for the bank to tighten credit until the last quarter of 2007, Yamazaki said. Business confidence in Japan probably fell from the highest in two years amid concern the U.S. economy may slow, the bank's Tankan survey may show next month.

The yen traded at 117.92 per dollar at 5:44 p.m. in Tokyo compared with 117.87 before the announcement. The yield on Japan's 10-year bond fell 1.5 basis points to 1.56 percent.

Today's decision was predicted by all 49 economists surveyed by Bloomberg News. Fukui said after last month's meeting that the board has no plans to raise rates consecutively.

The governor later told reporters that the U.S. economy remains likely to expand gradually, even after weak data raised concern that growth in Japan's largest export market may slow.

(...)

Reports may show Japan's core consumer prices dropped in February or March because of cheaper oil, Fukui said. Core prices, which exclude fresh food and are a key gauge of inflation in Japan, failed to rise in January after climbing 0.1 percent year- on-year in December.

Fukui said the drop in core prices wouldn't necessarily be bad because lower oil costs help economic growth. Core prices will stay on an expansionary path in the long term, he added.

Kazumasa Iwata, one of the bank's two deputy governors, said at the meeting that the policy makers should explain their outlook for consumer prices more clearly, according to Fukui. Iwata was the sole dissenter to last month's rate increase.

As always, Morgan Stanley's Japan watchers are also following the situation closely and the recent comment from Takehiro Sato as a preview of the Tankan business confindence survey which then failed to come through according to Mr. Sato's expectations of an increase relative to December. In fact, the survey showed that business confidence dropped albeit ever so slightly from the December figures.