Japan's Macroeconomic Outlook: Sailing in Gentle Breeze, Preparing for Stronger Winds

Key risk events including the UK General Election (July 4th), the FOMC Announcement (July 31st), and the BoJ Policy Announcement (July 31st).

Tuesday, 02 July, Week 27: Japan's economy has navigated through recent months, aided by government stimulus and accommodative monetary policy. However, the Bank of Japan's plans to reduce bond purchases may cause potential disruptions. This report analyzes Japan's economic landscape, covering fiscal and monetary policies, indicators, and risk factors, providing forex traders with a comprehensive outlook.

Fiscal Policy

Fiscal policy guides the economy by influencing spending, taxation, inflation, borrowing, interest rates, and investor confidence.

Over the past five months, Japan's government has been actively navigating the economy with expansionary fiscal policies. These include cuts to income tax and inhabitant tax, along with subsidies to mitigate the impact of higher energy prices on households. This approach has provided a tailwind for private consumption and business fixed investment. The FY2024 budget, unveiled in December 2023, further emphasises this course, focusing on addressing the nation's demographic challenges, promoting digital and green transformation, and bolstering national security.

The budget allocates 3.6 trillion yen to the "acceleration plan" under the Children's Future Strategy, with over 30% of this earmarked for FY2024. To fund this, the government plans to revise medical care fees and drug prices and reform long-term care insurance. Looking ahead, the government is expected to maintain this course, with the implementation of the FY2024 budget and potential additional stimulus measures acting as a steady tailwind for the economy.

• FY2024 budget: 112.57 trillion yen (a decrease of 1.6% from the initial FY2023 budget).

• Child allowance expansion: Removing income caps, expanding coverage to senior high school students, and increasing the allowance for the third or later child to 30,000 yen per month.

• Defence spending: Increase of 1.1 trillion yen from the previous fiscal year.

Economics

Economics guides understanding of forces shaping an economy, informing monetary policy and influencing financial markets.

Japan's economic performance over the past five months paints a picture of moderate growth, propelled by domestic demand. However, external demand has been becalmed, with exports remaining flat. The labour market has tightened, leading to wage increases, while inflation has remained elevated, though the pace of increase has moderated. Looking ahead, the economy is expected to continue its moderate growth trajectory, with the virtuous cycle of income and spending gaining momentum, fueled by wage increases and government stimulus. However, global economic uncertainties and the impact of rising interest rates could create headwinds.

Economic Growth:

• Past Five Months: Japan's GDP contracted by 0.5% qoq in Q1 2024, reversing from a 0.1% growth in Q4 2023. The annualised GDP growth rate was -1.8% in Q1 2024, compared to a preliminary reading of -2.0%. Private consumption fell for the fourth straight quarter (-0.7% qoq), marking the steepest fall in three quarters. Capital expenditure remained weak (-0.4% qoq), amid a reduction in auto production. Net trade was a drag on GDP, subtracting 0.2 percentage points.

• Contextual Forecasts: The BoJ expects the economy to continue growing at a pace above its potential growth rate. Trading Economics forecasts a GDP growth rate of 0.8% qoq by the end of Q2 2024.

• Assessment: The recent GDP contraction suggests a temporary lull in economic activity, likely due to factors like the earthquake in January and production disruptions in the auto industry. The BoJ and Trading Economics forecasts point to a resumption of growth in the coming months, supported by government stimulus and accommodative monetary policy.

• Q1 2024 GDP growth rate: -0.5% qoq, -1.8% annualised.

• Trading Economics forecast for Q2 2024 GDP growth rate: 0.8% qoq.

• BoJ's projected real GDP growth rate for fiscal 2024: 0.7% to 1.0%.

Labour:

• Past Five Months: The unemployment rate has held steady at 2.6% for the past four months. The number of employed persons has increased moderately, but the pace of increase has slowed. Nominal wages per employee have increased moderately, reflecting the recovery in economic activity and the results of last year's spring wage negotiations.

• Contextual Forecasts: The labour market is expected to remain tight, with the unemployment rate projected to decline moderately. Wage growth is expected to accelerate, supported by the tight labour market and the results of this year's spring wage negotiations.

• Assessment: The labour market remains a source of strength for the Japanese economy, with low unemployment and rising wages. The tight labor market is expected to continue providing a tailwind for wage growth, which in turn should support private consumption.

• Unemployment rate: 2.6% in May 2024.

• Jobs-to-applications ratio: 1.24 in May 2024 (lowest level in two years).

• Year-on-year rate of change in nominal wages per employee: Increased moderately in recent months.

Price Changes:

• Past Five Months: The CPI (all items less fresh food) has been in the range of 2.0-2.5% recently. The core inflation rate (excluding fresh food and energy) has increased to 2.5% in May 2024 from a three-month low of 2.2% in April. The impact of past high commodity prices has waned, but the recent rise in crude oil prices has put upward pressure on energy prices. The government's measures to reduce the household burden of higher gasoline prices, electricity charges, and gas charges have pushed down the year-on-year rates of change in the CPI (all items less fresh food) up through fiscal 2023. The phasing out of these measures is projected to push up the rates for fiscal 2024 and 2025.

• Contextual Forecasts: The BoJ expects the CPI (all items less fresh food) to be pushed up through fiscal 2025 by factors such as a waning of the effects of the government's economic measures pushing down CPI inflation. Underlying CPI inflation is expected to increase gradually, reflecting the improvement in the output gap and the rise in medium- to long-term inflation expectations. Trading Economics forecasts an inflation rate of 2.8% by the end of Q2 2024.

• Assessment: Inflation remains a key concern for the BoJ, with the CPI hovering above the 2% target. The phasing out of government subsidies on energy prices is expected to create a temporary headwind for inflation, while underlying inflationary pressures are expected to build gradually.

• CPI (all items less fresh food): 2.8% yoy in May 2024.

• Core inflation rate: 2.5% yoy in May 2024.

• BoJ's projected year-on-year rate of increase in the CPI (all items less fresh food) for fiscal 2024: 2.6% to 3.0%.

Trade:

• Past Five Months: Japan has recorded a trade deficit for the past two months. Exports have been more or less flat, affected by the slowdown in the pace of recovery in overseas economies. Imports have decreased recently, mainly due to shipping delays.

• Contextual Forecasts: Exports are projected to return to an uptrend, mainly due to a pick-up in global demand for IT-related goods. Imports are expected to follow a moderate uptrend on the back of developments in demand induced by increases in domestic demand and exports. The nominal current account balance is likely to follow a moderate improving trend.

• Assessment: The recent trade deficits suggest a temporary lull in external demand, likely due to factors like the slowdown in global economic growth and shipping delays. The BoJ's forecasts point to a resumption of export growth and an improving current account balance in the coming months.

• Trade deficit: 1,221 billion yen in May 2024.

• Current account surplus: 2,050.5 billion yen in April 2024.

• BoJ's projected nominal current account balance: Moderate improving trend.

Monetary Policy

Monetary policy, the central bank's management of interest rates and money supply, acts as an engine, controlling the speed and direction of the economy. It directly influences interest rates and financial markets, and it indirectly affects the economy through its impact on borrowing, investment, and consumption.

Over the past five months, the BoJ has maintained a course of accommodative monetary policy, keeping the key short-term interest rate anchored at around 0% to 0.1%. However, the Bank has signalled a change in wind direction, announcing its intention to reduce bond purchases. This decision, made in June, was passed by an 8-1 majority vote, with board member Nakamura Toyoaki dissenting, arguing for a reassessment of economic conditions before implementing the change.

The BoJ's move to reduce bond purchases is aimed at allowing long-term interest rates to move more freely, potentially leading to a rise in yields. This could create a headwind for economic growth, but it could also help to strengthen the yen. The market will be closely watching the BoJ's July meeting for details on the size and pace of the reduction, which will provide further clues about the Bank's policy direction.

Impact on the Economy, Monetary Policy, and Financial Markets:

• The BoJ's accommodative monetary policy has supported economic growth by keeping interest rates low.

• The Bank's decision to reduce bond purchases could lead to a rise in long-term interest rates, which could have a negative impact on economic growth.

• The yen could strengthen if the BoJ reduces bond purchases, as this would signal a tightening of monetary policy. The extent of the yen's appreciation will depend on the size and pace of the reduction, as well as market expectations.

Key Facts and Figures:

• Key short-term interest rate: 0% to 0.1%.

• Current monthly JGB purchases: Around 6 trillion yen.

• BoJ's projected year-on-year rate of increase in the CPI (all items less fresh food) for fiscal 2025: Around 2%.

"The Bank will encourage the uncollateralized overnight call rate to remain at around 0 to 0.1 percent." - BoJ Statement on Monetary Policy, June 14, 2024

"The Bank decided, by an 8-1 majority vote, that it would reduce its purchase amount of JGBs thereafter to ensure that long-term interest rates would be formed more freely in financial markets." - BoJ Statement on Monetary Policy, June 14, 2024

Market Risk

Market risk, the potential for losses due to changes in market conditions, acts as a barometer, reflecting investor sentiment and economic uncertainty. It can influence monetary policy by affecting asset prices and financial stability, and it can impact the economy by affecting investment and consumption decisions.

Significant Risk:

• US Presidential and Legislative Elections (November 5th, 2024): The outcome will determine the country's economic and foreign policies, potentially impacting USD and global markets. Uncertainty surrounding the election might initially weaken USD, but a clear outcome and policy direction could strengthen it. This could impact USD/JPY, potentially leading to yen weakness if USD strengthens.

• China's Third Plenum of the 20th Central Committee (July 15th-18th, 2024): This meeting will focus on China's economic direction. Announcements regarding stimulus measures, trade policies, or structural reforms could significantly impact Asian currencies, particularly CNY. Positive economic signals might strengthen CNY, particularly against USD (USD/CNY bearish). However, any negative news or escalating trade tensions could weaken CNY, leading to strength in USD and JPY (USD/CNY bullish, CNY/JPY bearish).

• Implementation of US tariffs on Chinese EVs and other strategic goods (August 1st, 2024): The implementation of US tariffs on Chinese goods will likely escalate trade tensions and impact USD/CNY. This could weaken CNY and potentially strengthen USD as investors seek safe-haven assets (USD/CNY bullish). However, the impact on USD might be limited if the tariffs negatively affect US businesses and consumers, potentially leading to weakness against other major currencies like EUR and JPY (EUR/USD, USD/JPY bearish).

Minor Risk:

• BoJ Policy Announcement (July 31st, 2024): The BoJ's policy announcement will be crucial for JPY, particularly regarding the decision on detailing its plan to reduce bond purchases. A significant reduction could strengthen JPY, leading to weakness in USD/JPY.

• FOMC Announcement (July 31st, 2024): The FOMC announcement will be crucial for USD. Any signals of a faster-than-expected rate cut timeline could weaken USD, potentially leading to strength in EUR/USD and USD/JPY.

• UK General Election (July 4th, 2024): The UK general election will significantly impact GBP pairs. Polls suggest a Labour victory, potentially leading to a more regulated economy and closer EU ties. This could initially weaken GBP due to uncertainty.

Conclusion

Japan's macroeconomic outlook presents a mixed picture for forex traders. The economy is navigating moderate seas, with a tailwind from government stimulus and accommodative monetary policy. However, the BoJ's decision to reduce bond purchases could create headwinds, potentially leading to a rise in long-term interest rates and a strengthening of the yen. Key risk events, such as the US elections and developments in China, could also create volatility in currency markets. Traders should closely monitor these factors to adjust their sails accordingly.

Reference

• Bank of Japan

• Cabinet Office, Japan

• Ministry of Finance, Japan

• Ministry of Internal Affairs & Communications, Japan

• Ministry of Economy Trade & Industry (METI), Japan

• Ministry of Health, Labour and Welfare, Japan

• Trading Economics

• S&P Global

• IMF

• OECD

• Bloomberg

• QUICK

• Consensus Economics Inc.

• Japan National Tourism Organization (JNTO)

• JTUC Research Institute for Advancement of Living Standards

• Teikoku Databank, Ltd.

• Tokyo Shoko Research, Ltd.

• Japan/Tokyo Chamber of Commerce and Industry (JCCI and TCCI)

• Japan Finance Corporation

• Nowcast Inc./ JCB, Co., Ltd.