Will the BoJ Embrace Rate Hikes and Taper Tantrum
BoJ's July meeting crucial for forex traders.
Sunday, 21 July, Week 30
A Child-Centric Budget: Can Fiscal Policy Spark a Virtuous Cycle?
Japan's fiscal policy has undergone a significant shift over the past five months, marked by a focus on child-centric policies and efforts to stimulate wage growth. The FY2024 budget, drafted in April, prioritises tackling the declining birthrate, deemed "Japan’s biggest crisis," through an "acceleration plan" under the Children’s Future Strategy. This plan, with a budget of 3.6 trillion yen, includes expanding child allowances, reducing higher education costs, and improving the quality of child education and care. To fund these initiatives, the government plans to revise medical care fees and drug prices, reform long-term care insurance, and implement thorough expenditure reforms by FY2028.
Currently, Japan's fiscal policy can be characterised as expansionary, aiming to stimulate economic growth through increased spending and targeted support measures. In the coming five weeks, the focus will likely be on implementing the FY2024 budget, particularly the child allowance expansion scheduled for December. The government will also likely continue to monitor the impact of its economic measures, such as the fixed-amount tax cut and the "Contingency Fund for Measures to Address Soaring Prices and Promote Wage Increases," on disposable income growth. The effectiveness of these measures in stimulating private consumption and driving a virtuous economic cycle will be crucial in determining future fiscal policy adjustments. Fiscal policy is essential as it directly influences aggregate demand, impacting economic growth, inflation, and employment. By adjusting spending and taxation, the government can steer the economy toward its desired trajectory. For forex traders, understanding fiscal policy developments is crucial as they can signal shifts in economic sentiment, impacting the Japanese yen's value.
A Fragile Recovery: Can Japan Overcome Economic Headwinds?
Japan's economic situation over the past five months has been characterised by a fragile recovery, grappling with headwinds from high inflation, sluggish wage growth, and external uncertainties. While the economy has shown signs of moderate growth, with business fixed investment on an increasing trend and private consumption remaining resilient, concerns linger about the sustainability of this recovery. The first quarter of 2024 saw a contraction in GDP, driven by a decline in private consumption and capital expenditure, highlighting the vulnerability of the economy to both domestic and external shocks.
Currently, Japan's economic situation can be defined as one of cautious optimism, with the potential for sustained growth but facing significant challenges. In the coming five weeks, the focus will be on whether the government's fiscal and monetary policy measures can effectively stimulate private consumption and investment. The impact of the Bank of Japan's recent policy shift, including the first rate hike since 2007 and the potential tapering of bond purchases, will also be closely watched. The performance of key economic indicators will provide crucial insights into the trajectory of the economy.
Key Economic Indicators:
GDP Growth Rate: Japan's GDP contracted by 0.5% qoq in Q1 2024, reversing from an upwardly revised 0.1% growth in Q4 2023. "Private consumption, which accounts for more than half of the economy, fell for the fourth straight quarter (-0.7%, in line with the initial reading and market consensus, after a 0.4% drop in Q4), marking the steepest fall in 3 quarters as consumers continued to reduce their spending in the face of expensive costs of living and sluggish wages, and after a strong quake that struck Noto peninsula in January." Trading Economics forecasts GDP growth to reach 0.8% by the end of Q2 2024, with long-term projections trending around 0.4% in 2025.
Inflation Rate: The annual inflation rate in Japan held steady at 2.8% in June 2024, remaining at its highest level since February. "Electricity prices stayed elevated (13.4% vs 14.7% in May) while the cost of gas rose for the first time in 13 months (2.4% vs -2.5%) after energy subsidies fully ended in May." Trading Economics expects inflation to reach 2.5% by the end of Q3 2024, with long-term projections trending around 1.6% in 2025.
Core Inflation Rate: The core consumer price index in Japan increased by 2.6% year-on-year in June 2024, accelerating for the second straight month. "Japan’s core inflation rate has now stood at or above 2% for over two years."
Unemployment Rate: Japan's unemployment rate remained at 2.6% in May 2024, matching market forecasts. "It remained the highest jobless rate since September 2023, as the number of unemployed edged down by 10 thousand to 1.82 million while employment added 10 thousand to a three-month top of 67.61 million."
Housing Starts: Japan's housing starts declined by 5.3% year-on-year in May 2024, indicating the fourth time of drop so far this year. "New dwellings fell across all categories: owned (-8.7% vs -3.9% in April), rented (-5.3% vs 20.6%), issued (-54.6% vs 331.5%), built-for-sale (-0.9% vs 16.5%), pre-fabricated (-18.1% vs -6.4%), and two-by-four (-3.0% vs 37.4%)."
Business Confidence: The Reuters Tankan sentiment index for manufacturers in Japan jumped to +11 in July 2024 from +6 in June, improving for the first time in 4 months and posting the highest reading in 7 months. "The latest survey comes two weeks before the central bank’s July policy meeting where it could raise interest rates again and announce its bond purchase tapering plans." The Bank of Japan's Tankan index of sentiment among large manufacturers rose to plus 13 in Q2 2024 from plus 11 in the previous quarter, hitting the highest level in two years.
Consumer Confidence: The consumer confidence index in Japan increased to 36.4 in June 2024 from May’s six-month low of 36.2. "Households’ sentiments improved for income growth (40.6 vs 39.9 in May) and willingness to buy durable goods (29.6 vs 29.0)." Trading Economics expects consumer confidence to reach 35.0 by the end of Q3 2024, with long-term projections trending around 37.0 in 2025.
Retail Sales: Retail sales in Japan increased by 3% year-on-year in May 2024, accelerating from an upwardly revised 2.4% gain in April. "The latest figure also marked the 26th consecutive month of expansion in retail turnover as rising wages continued to boost consumption."
Balance of Trade: Japan posted a trade surplus of JPY 224.04 billion in June 2024, beating market forecasts of a deficit of JPY 240 billion. "It was also the second time of surplus so far this year in trade balance with shipments rising by 5.4% yoy, the seventh consecutive month of growth, supported by robust sales to main trading partners, notably the US and China." Trading Economics expects the balance of trade to reach JPY 300 billion by the end of Q3 2024, with long-term projections trending around JPY 50 billion in 2025.
Exports: Exports from Japan rose by 5.4% yoy to JPY 9,208.64 billion in June 2024, marking the seventh straight month of increase. "The latest result, however, was below market forecasts of 6.4%, easing from a 13.5% jump in May and marking the softest growth since last November."
The performance of these indicators in the coming five weeks will be crucial in assessing the strength and sustainability of Japan's economic recovery. Forex traders will closely monitor these indicators for signals of potential shifts in monetary policy and the yen's value.
A Policy Pivot: Will the BoJ Hike Rates Again?
Japan's monetary policy has undergone a significant shift in the past five months, marked by the Bank of Japan's (BoJ) decision to raise interest rates for the first time since 2007 in March 2024, ending eight years of negative rates. This move, driven by rising wages and high inflation, signalled a pivot away from the ultra-loose monetary policy that had characterised Japan's economy for years. The BoJ maintained its key short-term interest rate at around 0% to 0.1% at its June meeting, but indicated that it may consider reducing bond purchases at its July meeting. "The move was passed by an 8-1 majority vote, with board member Nakamura Toyoaki dissenting, aiming to allow long-term rates to move more freely. The BoJ currently purchases about JPY 6 trillion in bonds per month."
Currently, Japan's monetary policy can be defined as cautiously accommodative, seeking to balance the need to support economic growth with the imperative to address rising inflation. The coming five weeks will be crucial in determining the BoJ's next steps. The central bank's July meeting is widely anticipated, with market expectations for a potential rate hike and the announcement of bond purchase tapering plans. The BoJ's assessment of the economy's resilience, inflation trends, and the impact of its previous policy changes will be key factors in its decision-making. "Friday's statement mentioned that Japan's economy had recovered moderately despite fragility in some areas. Private consumption was resilient amid improving corporate profits and business spending. Exports, however, have been flat, as did public investment. On inflation, the yoy figures have been in the range of 2 to 2.5%, with inflation expectations rising modestly. Meanwhile, underlying CPI is expected to increase gradually."
Monetary policy is a powerful tool that central banks use to influence economic activity by adjusting interest rates and controlling the money supply. By making borrowing more or less expensive, the BoJ can stimulate or restrain spending and investment, impacting inflation, employment, and economic growth. For forex traders, understanding monetary policy developments is crucial as they can significantly impact the value of the Japanese yen.
Navigating a Sea of Uncertainty: Risks to Japan's Economic Outlook
Top Three Risks (Previous Five Months):
Daihatsu Scandal (February-March 2024): A scandal involving Daihatsu Motor, a major Japanese automaker, led to a reduction in auto production, impacting capital expenditure and industrial production.
Key Developments: Production suspension, investigation, impact on supply chains.
Noto Peninsula Earthquake (January 1, 2024): A strong earthquake struck the Noto Peninsula, causing significant damage to infrastructure and disrupting economic activity.
Key Developments: Infrastructure damage, displacement, impact on consumer spending.
Middle East Geopolitical Tensions (April-July 2024): Heightened geopolitical risks in the Middle East, including increased tensions between Iran and Israel, have impacted global financial markets and raised concerns about potential disruptions to energy supplies.
Key Developments: Oil price volatility, shipping disruptions, impact on investor sentiment.
Top Three Risks (Following Five Weeks):
BoJ Policy Tightening (July 31, 2024): The BoJ's potential rate hike and bond purchase tapering plans could lead to higher borrowing costs, impacting business investment and consumer spending. This could also trigger volatility in the Japanese yen and government bond markets.
Global Economic Slowdown (July-August 2024): A potential slowdown in global economic growth, driven by factors such as high inflation and tighter monetary policy in major economies, could negatively impact Japan's exports and overall economic activity.
China's Economic Uncertainty (July-August 2024): Uncertainty surrounding the pace and sustainability of China's economic recovery could impact Japan's exports and supply chains, given the close economic ties between the two countries.
Conclusion
Japan's macroeconomic outlook for the next five weeks hinges on the delicate balance between supporting a fragile recovery and addressing rising inflation. The BoJ's July meeting will be a pivotal event, with potential policy changes that could significantly impact the yen and financial markets. Forex traders should closely monitor key economic indicators, fiscal policy developments, and geopolitical risks to navigate the uncertainties ahead.
Action Points:
Monitor the BoJ's July 31st meeting for potential rate hikes and bond purchase tapering announcements.
Track key economic indicators, particularly GDP growth, inflation, and trade data, for signs of economic strength or weakness.
Assess the impact of the government's fiscal policy measures on consumer spending and wage growth.
Stay informed about geopolitical developments in the Middle East and their potential impact on energy prices and global financial markets.
Key Economic Events (Next Five Weeks):
BoJ Interest Rate Decision (Wednesday, July 31, Week 31)
BoJ Quarterly Outlook Report (Wednesday, July 31, Week 31)
Japan Unemployment Rate (Tuesday, July 30, Week 31)
Japan Industrial Production (Wednesday, July 31, Week 31)
Japan Retail Sales (Wednesday, July 31, Week 31)
Sources:
Trading Economics
Bank of Japan
Ministry of Internal Affairs & Communications
Statistics Bureau of Japan
Ministry of Economy Trade & Industry (METI)
Ministry of Land, Infrastructure, Transport and Tourism
Reuters Tankan
S&P Global
Cabinet Office, Japan
Ministry of Finance, Japan
IMF "World Economic Outlook"
OECD "Economic Outlook 114"