BoJ Tightening Cycle Sends Shockwaves Through Markets, But Will it Be Enough?
Japan's economic outlook balances growth, inflation, and stimulus. Upcoming events will reveal policy effectiveness and yen value.
Wednesday, 31st July, Week 31
Children First: Japan's Fiscal Policy Takes a Bold Stance
Over the past five months, Japan's fiscal policy has been characterised by a commitment to tackling the nation's demographic challenges, particularly the declining birthrate. This has been most evident in the government's "acceleration plan" under the Children's Future Strategy, which includes significant spending increases on child allowances, education, and childcare. The FY2024 draft budget reflects this focus, with the budget for the Children and Families Agency increasing by 0.5 trillion yen from the previous year to 5.3 trillion yen. This expansionary fiscal policy is aimed at stimulating economic growth by boosting consumption and supporting families. In the coming five weeks, the government will likely continue to emphasise its commitment to children and families, seeking to balance these priorities with the need for fiscal sustainability. This focus on fiscal stimulus is expected to have a positive impact on the macroeconomic situation by supporting domestic demand and potentially boosting inflation. However, the effectiveness of this policy will depend on the extent to which it can encourage a sustained increase in consumer spending. Fiscal policy is crucial because it directly impacts aggregate demand and can be used to influence economic growth, inflation, and employment. In Japan's case, the government's focus on tackling the declining birthrate is not only an economic strategy but also a long-term social policy aimed at ensuring the nation's future sustainability. As stated in the FY2024 draft budget, "Under the recognition that the declining birthrate represents Japan’s biggest crisis, the government will implement the “acceleration plan” under the Children’s Future Strategy with a sense of urgency."
Japan's Economy: A Balancing Act Between Growth and Inflation
Japan's economic situation has been characterised by a mixed performance over the past five months. While the economy has shown signs of recovery, with corporate profits improving and business fixed investment on an increasing trend, private consumption has remained relatively weak due to high inflation and sluggish wage growth. The first quarter of 2024 saw a slight expansion in GDP, driven by a rise in government spending and net trade, but private consumption remained weak. However, there have been some positive developments in recent months, including a rise in exports and a tightening labour market. The current economic situation can be described as one of cautious optimism, with the potential for stronger growth if inflation can be brought under control and wage growth accelerates. In the coming five weeks, the focus will be on the Bank of Japan's monetary policy decision and the release of key economic data, including the second quarter GDP figures and the July inflation rate. These releases will provide further insights into the health of the economy and the effectiveness of the government's fiscal and monetary policies. The nation's economic situation is important because it directly impacts the value of the yen and the attractiveness of Japanese assets to foreign investors.
Economic Growth:
GDP Growth Rate (QoQ): 0.1% in Q1 2024. The second quarter GDP figures, due to be released on 15th August (Thursday, Week 33), will be closely watched for signs of continued growth. The Bank of Japan projects a growth rate of 0.8% for the second quarter.
GDP Growth Annualised: 0.4% in Q1 2024. The annualised growth rate is expected to improve in the second quarter, but the pace of recovery remains uncertain. The Bank of Japan projects an annualised growth rate of 3.5% for the second quarter.
Price Changes (Inflation):
Inflation Rate (YoY): 2.8% in June 2024. Inflation is expected to remain elevated in the coming weeks, driven by the waning effects of government subsidies and the potential for further pass-through of cost increases to consumer prices. The Bank of Japan projects inflation to be around 2.5% for fiscal year 2024.
Core Inflation Rate (YoY): 2.6% in June 2024. Core inflation, which excludes volatile food and energy prices, is also expected to remain above the Bank of Japan's 2% target in the coming weeks. The Bank of Japan projects core inflation to be around 2% for fiscal years 2025 and 2026.
Labour:
Unemployment Rate: 2.5% in June 2024. The unemployment rate is subject to future economic developments. The Bank of Japan's outlook suggests continued improvement in the labour market, but uncertainties remain.
Jobs-to-Applications Ratio: 1.23 in June 2024. The jobs-to-applications ratio, a measure of labour market tightness, is expected to remain elevated, indicating continued strong demand for labour.
Housing:
Housing Starts (YoY): -6.7% in June 2024. Housing starts have been weak in recent months, reflecting high construction costs and rising interest rates. This trend is expected to continue in the coming weeks.
Business Confidence:
Reuters Tankan Index: +11 for manufacturers in July 2024. Business confidence among manufacturers has improved in recent months, but the outlook remains uncertain. The August Tankan survey, due to be released on 16th August (Friday, Week 33), will provide further insights into business sentiment.
Machinery Orders (MoM): -3.2% in May 2024. Machinery orders, a leading indicator of capital expenditure, have been volatile in recent months. The June machinery orders figures, due to be released on 19th August (Monday, Week 34), will be closely watched for signs of a sustained recovery in business investment.
Consumer Sentiment:
Consumer Confidence: 36.7 in July 2024. Consumer confidence has improved slightly in recent months, but remains relatively low due to high inflation. The August consumer confidence figures, due to be released on 30th August (Friday, Week 35), will provide further insights into consumer sentiment.
Trade:
Balance of Trade: ¥224.0 billion surplus in June 2024. The trade balance has been volatile in recent months, reflecting fluctuations in global demand and the value of the yen. The July trade balance figures, due to be released on 21st August (Wednesday, Week 34), will be closely watched for signs of a sustained improvement in exports.
Exports (YoY): 5.4% in June 2024. Exports have been growing in recent months, supported by robust demand from key trading partners. However, the pace of growth is expected to moderate in the coming weeks due to slowing global economic growth.
A Cautious Pivot: The Bank of Japan Takes a Step Towards Normalisation
The Bank of Japan's monetary policy has been characterised by a gradual shift towards normalisation over the past five months. In July 2024, the BOJ raised its key short-term interest rate to 0.25% from the prior range of 0 to 0.1% it set in March. The central bank also announced plans to reduce its monthly bond purchases, signalling a move away from its ultra-loose monetary policy. The current monetary policy can be described as accommodative but less so than in previous years. The BOJ is attempting to balance the need to support economic growth with the need to control inflation and prevent a sharp depreciation of the yen. In the coming five weeks, the focus will be on the BOJ's communication regarding its future policy intentions. The central bank is expected to maintain its cautious approach, but further rate hikes and a more aggressive reduction in bond purchases are possible if inflation continues to accelerate. Monetary policy is important because it influences interest rates, exchange rates, and the overall availability of credit in the economy. In Japan's case, the BOJ's monetary policy has played a key role in supporting economic growth and combating deflation in recent years. However, the central bank is now facing the challenge of normalising its policy without disrupting the economy or causing a sharp appreciation of the yen. As stated in the July 2024 Outlook Report, "As for the conduct of monetary policy, while it will depend on developments in economic activity and prices as well as financial conditions going forward, given that real interest rates are at significantly low levels, if the aforementioned outlook for economic activity and prices will be realised, the Bank will accordingly continue to raise the policy interest rate and adjust the degree of monetary accommodation."
Navigating the Storm: Risks to Japan's Economic Outlook
Past Risks (March-July 2024):
Global Inflationary Pressures (March-July 2024): High inflation in major economies, particularly the United States and Europe, has put upward pressure on import prices in Japan, contributing to domestic inflation and eroding consumer purchasing power.
The US Federal Reserve and the European Central Bank have raised interest rates aggressively to combat inflation.
Supply chain disruptions and the war in Ukraine have contributed to higher commodity prices.
The yen has depreciated against the US dollar, making imports more expensive.
China Economic Growth Moderation (April-July 2024): China's economic growth has moderated in recent months, driven by a combination of factors, including COVID-19 lockdowns, a property market downturn, and weak consumer spending. This has had a mixed impact on the Japanese economy, as weaker demand from China has contributed to lower commodity prices, but has also weighed on Japanese exports.
Key Developments:
China's GDP growth slowed to 0.8% year-on-year in the second quarter of 2024.
The Chinese government has implemented stimulus measures to support the economy, but the effectiveness of these measures remains uncertain.
Future Risks (August-September 2024):
Further BOJ Tightening (August-September 2024): The Bank of Japan could raise interest rates again or reduce its bond purchases more aggressively in the coming weeks if inflation continues to accelerate. This could have a negative impact on economic growth and could lead to a sharp appreciation of the yen.
Conclusion: Japan's Macroeconomic Outlook Hinges on Inflation and Policy Choices
Japan's macroeconomic outlook for the next five weeks is characterised by a delicate balancing act between supporting economic growth and controlling inflation. The Bank of Japan's recent rate hike and plans to reduce bond purchases signal a shift towards normalisation, but the central bank is expected to remain cautious in its approach. The government's expansionary fiscal policy, focused on tackling the declining birthrate, is aimed at stimulating domestic demand, but its effectiveness will depend on the extent to which it can encourage a sustained increase in consumer spending. Key events to watch in the coming weeks include the release of the second quarter GDP figures on 15th August (Thursday, Week 33), the July inflation rate on 23rd August (Friday, Week 34), and the August Tankan survey on 16th August (Friday, Week 33). These releases will provide further insights into the health of the economy and the effectiveness of the government's fiscal and monetary policies. Forex traders should closely monitor these developments, as they will have a significant impact on the value of the yen and the attractiveness of Japanese assets.
Sources:
Bank of Japan: "Outlook for Economic Activity and Prices (July 2024)", "Change in the Guideline for Money Market Operations and Decision on the Plan for the Reduction of the Purchase Amount of Japanese Government Bonds", "Summary of Opinions at the Monetary Policy Meeting on June 13 and 14, 2024"
Ministry of Finance, Japan: "Highlights of the FY2024 Draft Budget"
Cabinet Office, Japan: "Consumer Confidence Survey"
Trading Economics
Reuters
S&P Global
OECD
IMF