Japan economy shrinks more than expected, supporting BoJ easing

Japan economy shrinks more than expected, supporting BoJ easing

Japan’s economy slipped back into reverse over the summer, pointing to the fragility of the country’s recovery and backing the case for continued Bank of Japan easing and the government’s recent economic package.

Gross domestic product shrank at an annualized pace of 2.1% in the third quarter, largely on the back of falling business spending and higher imports that dragged on the economy, the Cabinet Office reported Wednesday.

An expected increase in consumer spending also failed to materialize. The contraction was much deeper than economists’ estimate of a 0.4% shrinkage. The yen weakened a tad against the dollar following the release.

Wednesday’s data suggest that Japan’s economic recovery is more fragile than previously thought, and in need of continued government and central bank support. The results may give the BOJ a reason to delay any policy shift toward normalization, in the face of continued uncertainties including currency weakness, prolonged inflation and a cloudy outlook overseas.

“This is a weak result,” said Tsukasa Koizumi, an economist at Hamagin Research Institute. “Particularly consumer spending — I thought the summer service sector spending was fairly solid so the fact that that’s fallen is significant. The inflation we’re seeing is strengthening households’ desire to cut back on spending.”

BOJ Governor Kazuo Ueda has maintained that the bank will stand pat until there are clearer signs that a virtuous cycle of wages, prices and growth is strengthening. Still, Ueda also recently hinted that Japan is making progress toward its 2% stable inflation target, a prerequisite for policy normalization, fueling speculation over a possible early shift.

The contraction was partly driven by imports, which rebounded from a sharp drop in the spring, with net exports subtracting 0.1 percentage points from the overall GDP figure.

Businesses’ capital spending also decreased 0.6% after a 1% drop in the previous quarter, indicating that companies continued to cut back on investments amid price hikes, despite the increasing need for digitalization to tackle labor shortages.

What Bloomberg Economics Says...

“We expect GDP to shrink again in 4Q, when slowing demand from China and the US will probably hit exports. The contraction will probably be mild, but the outlook is weak enough that the Bank of Japan isn’t likely to pivot away from extreme stimulus anytime soon.”

— Taro Kimura, economist

For the full report, click here.

The weak yen has also kept inflation sticky, continuing to weigh on consumer spending. Private consumption failed to grow as expected from the previous quarter. Analysts had forecast a 0.3% increase.

Higher prices, coupled with sluggish pay growth, may risk a further cooling of consumer confidence going ahead.

The government recently added spending to support domestic demand through Prime Minister Fumio Kishida’s latest economic package worth over ¥17 trillion.

The measures center on income tax cuts and handouts to low-income households to help them deal with higher prices. The Cabinet Office estimates the measures, could boost the economy by 1.2% annually over the next three years.