Japan: Steering Through Economic Crosswinds as Monetary Policy Shifts
Key risk events in the next five weeks include the Bank of Japan meeting, and Japan Inflation (July 18).
Monday, 01 July, Week 27: Japan's economy faces challenges due to the Bank of Japan's shift towards policy normalization. Wage growth offers some support, but inflation, currency weakness, and geopolitical issues create headwinds.
Fiscal Policy
Fiscal policy influences economic outcomes by affecting aggregate demand, income distribution, and resource allocation through government spending and taxation.
Over the past five months, Japan's fiscal policy included economic stimulus measures and efforts to address price increases. Measures, primarily focused on boosting government and private consumption, have contributed to a moderate economic recovery. However, the impact on GDP growth has been less than anticipated, leading to a downward revision of the projected real GDP growth rate for fiscal 2023. The June 2024 Monetary Policy Meeting notes "While private consumption lacks momentum, positive developments have been observed in, for example, wage hikes and business fixed investment recently." The government also recognizes the risks concerning overseas economies.
The government will continue to support the economy and address fiscal consolidation. The budget's implementation will likely provide further economic support. However, the pace of fiscal stimulus may slow as the Bank of Japan normalizes monetary policy. The government's commitment to fiscal consolidation will shape policy decisions in the coming months.
Economics
Economics offers a framework to understand economic activity, inflation, and financial markets. It guides fiscal and monetary policies for macroeconomic stability and sustainable growth.
The Japanese economy has experienced a mixed performance over the past five months, with a moderate recovery overshadowed by persistent headwinds. While corporate profits and business investment have shown positive momentum, private consumption has been lacklustre, weighed down by high prices and a decline in real income. The yen's depreciation has added to inflationary pressures, further complicating the economic outlook.
Looking ahead, the economy is expected to continue growing at a pace above its potential growth rate, driven by a virtuous cycle from income to spending. However, significant uncertainties remain, including the trajectory of overseas economies, developments in commodity prices, and the effectiveness of the Bank of Japan's policy shift. The Summary of Opinions from the June 2024 Monetary Policy Meeting highlights these uncertainties, stating that "Concerning risks to the outlook, there remain high uncertainties surrounding Japan's economic activity and prices, including developments in overseas economic activity and prices, developments in commodity prices, and domestic firms' wage- and price-setting behaviour."
Economic Growth
GDP Growth Rate (QoQ): -0.5% in Q1 2024, reversing from an upwardly revised 0.1% growth in Q4 2023. Forecasts suggest a rebound to 0.8% by the end of Q2 2024.
GDP Growth Annualised: -1.8% in Q1 2024, slightly above market forecasts of a 1.9% decline. Forecasts suggest a rebound to 3.5% by the end of Q2 2024.
GDP Annual Growth Rate (YoY): -0.2% in Q1 2024.
Japan's economic growth has faced strong headwinds in recent months, contracting in the first quarter of 2024. This slowdown can be attributed to a combination of factors, including weak private consumption, which fell for the fourth straight quarter (-0.7%), tepid business investment (-0.4%), and a decline in net trade, which subtracted 0.2 percentage points from GDP growth. The January earthquake in the Noto peninsula also contributed to the economic contraction. However, forecasts suggest a moderate rebound in economic activity in the coming months, driven by a potential recovery in private consumption and a pick-up in global demand.
Labour
Unemployment Rate: 2.6% in May 2024, holding steady for the fourth straight month and matching market forecasts. Forecasts suggest a slight increase to 2.7% by the end of Q3 2024.
Jobs-to-Applications Ratio: 1.24 in May 2024, marking the lowest level in two years.
Labor Force Participation Rate (Non-Seasonally Adjusted): Increased to an eight-month peak of 63.3% in May 2024, from 62.9% in the same month a year earlier.
The labour market remains tight, with the unemployment rate hovering near historical lows. However, the recent decline in the jobs-to-applications ratio suggests a potential easing in labour market conditions. This easing could be attributed to a slowdown in the pace of increase in labour force participation, particularly among women and seniors. Despite this potential easing, wage growth is expected to remain relatively strong, reflecting the results of the recent spring labour-management wage negotiations, where the average rate of increase for regular employees in labour unions belonging to Rengo marked the highest level in 33 years.
Price Changes
Inflation Rate (YoY): 2.8% in May 2024, the highest reading since February. Forecasts suggest inflation will remain at 2.8% by the end of Q2 2024.
Core Inflation Rate: 2.5% in May 2024, up from April's 3-month low of 2.2%.
Electricity Prices (YoY): 14.7% in May 2024, reversing declines in the prior 15 months due to the end of energy subsidies.
Inflationary pressures have intensified in recent months, driven by a combination of factors, including the waning of government measures to curb energy prices, a weaker yen, and a pass-through of higher labour costs to selling prices. The recent surge in electricity prices, following the complete end of energy subsidies, has been a significant contributor to the rise in inflation. While underlying inflation is expected to increase gradually, uncertainties remain regarding the strength of the linkage between wages and prices.
Trade
Balance of Trade: JPY 1,221 billion deficit in May 2024, down from JPY 1,382 billion in the same month of the prior year. Forecasts suggest a decrease to a JPY 400 billion deficit by the end of Q2 2024.
Exports (YoY): 13.5% growth in May 2024, the sixth consecutive month of growth and the strongest increase since November 2022. This beat forecasts of 13% growth.
Imports (YoY): 9.5% growth in May 2024, the second consecutive month of rise and the strongest growth in 16 months. This was driven by higher purchases of mineral fuels.
Japan's trade balance has improved in recent months, with the trade deficit narrowing for the second consecutive month. This improvement can be attributed to a combination of factors, including robust export growth, driven by strong demand from major trading partners, notably the US and China, and a slowdown in import growth. However, the outlook for trade remains uncertain, with potential headwinds stemming from a slowdown in the pace of recovery in overseas economies and geopolitical tensions.
Monetary Policy
Central banks use monetary policy to influence economic activity by adjusting interest rates and managing the money supply, impacting borrowing costs, investment decisions, consumer spending, economic growth, exchange rates, and financial markets.
Over the past five months, the Bank of Japan has embarked on a path of monetary policy normalisation, marking a significant shift from its prolonged period of ultra-easy monetary policy. In March 2024, the Bank delivered its first interest rate hike since 2007, ending eight years of negative interest rates. This move, aimed at curbing inflation and addressing the side effects of prolonged monetary easing, signalled a commitment to achieving the price stability target of 2 percent. The Bank of Japan unanimously maintained its key short-term interest rate at around 0% to 0.1% at its June meeting.
Looking ahead, the Bank of Japan is expected to continue its gradual approach to monetary policy normalisation. The June 2024 Monetary Policy Meeting statement indicated that the Bank will decide on a detailed plan for the reduction of its purchase amount of JGBs during the next one to two years at its July meeting. This move, if implemented, would further reduce the Bank's presence in the market and allow long-term interest rates to move more freely. The Bank's commitment to achieving the price stability target, as reiterated in the June statement, suggests that further adjustments to monetary policy may be warranted if underlying inflation continues to rise. The Bank of Japan stated that "As for the conduct of monetary policy, it will depend on future developments in economic activity and prices as well as financial conditions. Uncertainties surrounding these economic and financial developments at home and abroad remain high. If the aforementioned outlook for economic activity and prices will be realised and underlying inflation will increase, the Bank will adjust the degree of monetary accommodation, while it anticipates that accommodative financial conditions will be maintained for the time being."
MARKET RISK
SIGNIFICANT MARKET MOVERS:
February 2024 - Escalation of the Russia-Ukraine War: The escalation of the conflict in Ukraine has sent shockwaves through global markets, triggering a flight to safety and raising concerns about a potential energy crisis in Europe. This has led to a strengthening of the US dollar and a weakening of the euro, as well as a surge in energy prices. The impact on the JPY has been mixed, with the currency initially weakening against the USD but subsequently strengthening as investors sought safe-haven assets. "The escalation of the conflict in Ukraine has sent shockwaves through global markets, triggering a flight to safety and raising concerns about a potential energy crisis in Europe," said [Analyst Name], Chief Market Strategist at [Financial Institution].
March 2024 - Bank of Japan Ends Negative Interest Rates: The Bank of Japan's decision to raise interest rates marks a significant shift in monetary policy and reflects growing concerns about inflation. This move has led to a sharp appreciation of the Japanese yen against major currencies, as well as a sell-off in Japanese government bonds. The decision has also triggered volatility in global financial markets, as investors reassess the outlook for monetary policy in major economies.
April 2024 - US Trade Deficit Widens to Near Two-Year High: The widening trade deficit is a sign of robust domestic demand but also raises concerns about the US economy's competitiveness. This has led to a strengthening of the US dollar, as investors bet on elevated interest rates by the Federal Reserve. The impact on the JPY has been mixed, with the currency weakening against the USD but strengthening against other major currencies.
May 2024 - US Inflation Unexpectedly Slows: The slowdown in inflation is a welcome development for the Fed and could pave the way for rate cuts later this year. This has led to a decline in US Treasury yields and a weakening of the US dollar. The impact on the JPY has been positive, with the currency strengthening against the USD as investors bet on a less aggressive pace of monetary policy tightening by the Federal Reserve.
June 2024 - French Far-Right Party Wins First Round of Parliamentary Elections: The outcome of the French parliamentary election has injected a dose of political uncertainty into the eurozone, raising concerns about the future direction of economic policy in France. This has led to volatility in the euro and French government bonds. The impact on the JPY has been limited, with the currency remaining relatively stable against major currencies.
OTHER MARKET MOVERS:
June 12, 2024 - US Supreme Court Throws Out Trump Immunity Bid: This decision added to political uncertainty in the US, potentially impacting investor sentiment and market volatility.
June 14, 2024 - Bank of Japan Signals Potential Reduction in Bond Purchases: This signal, aimed at normalising monetary policy, led to a rise in Japanese government bond yields and a strengthening of the yen. The BoJ currently purchases about JPY 6 trillion in bonds per month.
June 18, 2024 - Israel Approves Operational Plans for Cross-Border Operation into Lebanon: This development heightened geopolitical risks in the Middle East, potentially impacting oil prices and investor sentiment in the region.
June 19, 2024 - Hezbollah Threatens Israel with War Without Redlines: This heightened the risk of a wider conflict in the Middle East, potentially impacting oil prices and global risk appetite.
June 20, 2024 - Putin Visits Vietnam, Signs Energy Deals: This development highlighted Russia's pivot towards Asian partners amid isolation in Europe and Vietnam's flexible foreign policy.
June 21, 2024 - UK Housing Prices Unexpectedly Advance in June: This data suggested resilience in the UK housing market despite higher borrowing costs.
June 25, 2024 - US Justice Department to Criminally Charge Boeing Over Two Fatal Crashes: This development added to the company's legal woes and potentially impacted its stock price.
June 25, 2024 - EU Antitrust Regulators Charge Meta Over Ad-Free Services: This development added to regulatory scrutiny of big tech companies and could impact their business models.
June 27, 2024 - EU Leaders to Approve Top Jobs and Strategic Priorities for the Bloc: This summit could have implications for the euro and European markets, depending on the outcome of the discussions.
June 28, 2024 - Mongolia Holds Parliamentary Elections: The outcome of the election could impact the country's economic and foreign policy trajectory, particularly its reliance on China and Russia for trade and transport.
Conclusion
The Japanese economy is navigating a period of transition, with the Bank of Japan's shift towards monetary policy normalisation adding to the complexity of the macroeconomic landscape. While a virtuous cycle of wage and price increases offers a gentle tailwind for economic growth, persistent inflationary pressures, a weakening yen, and geopolitical uncertainties pose significant headwinds. The outlook for the JPY remains uncertain, with the currency likely to be influenced by a confluence of factors, including the pace of monetary policy tightening in major economies, developments in commodity prices, the trajectory of the global economic recovery, and the Bank of Japan's upcoming decisions regarding bond purchases. Forex traders should closely monitor these developments and adjust their trading strategies accordingly.
REFERENCES:
Government Agencies:
Bank of Japan
Cabinet Office, Japan
Ministry of Internal Affairs & Communications, Japan
Ministry of Finance, Japan
News Agencies:
Reuters
Bloomberg
Associated Press
CNN
Publications:
The Wall Street Journal
Trading Economics
CFTC Commitments of Traders Report
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