Japan: Wave of concern

As expected, the Bank of Japan did not change its monetary policy at its latest meeting on 14 and 15 July. The BoJ kept its policy rate at -0.1%, its target for 10-year JGB yields at 0%, and the Bank maintained its asset purchasing program. The BoJ ended its policy statement hinting at a wait and see stance for now, which is also what we expect for the time being. This is understandable, since both the BoJ and the Japanese government have implemented enormous stimulus packages to fight the economic effects of the coronavirus.

The BoJ’s stimulus package (called the Special Program) represents about 21% of GDP, while the government stimulus package represents about 43% of GDP. The latter means that the Japanese budget deficit will be enormous as well and will lead to a big increase in public debt. Fortunately, the interest rate on this debt is close to zero. Moreover, the BoJ will absorb a big chunk of the newly issued Japanese Government Bonds to finance the increased budget deficit.

Nonetheless, Japan’s economic outlook does not appear bright this year. The BoJ’s own Outlook reveals that the Bank has become more uncertain about Japan’s economic outlook and a bit gloomier. The BoJ’s growth forecast for 2020 is now -4.7%, which is close to our estimate of -4.8%.

Meanwhile inflation in Japan remains very weak, headline inflation was only 0.1% y/y in June, and we still expect deflation this year. Mostly because of economic weakness, but also because oil prices have dropped 34% since the beginning of this year (Japan is a major oil importer), and because of the strength of the Japanese yen. JPY has strengthened against USD by about 3% since the beginning of this year. And although the current broader USD weakness may be a bit overdone, political instability in Asia (which is anything but scarce these days) will likely strengthen JPY further, depressing inflation and hurting Japan’s exports.

Losing export competitiveness is the last thing Japan needs, exports already plunged by 26% y/y in June. Given the weakness of the global economy, this will not pick up strongly anytime soon. If JPY strengthens against USD to levels below 100, that might trigger a rethink of further monetary as well as fiscal stimulus. That said, we don’t expect USD/JPY to fall that low.

Japan is dealing with a second wave of coronavirus infections since July, although the number of deaths has remained relatively stable (figure 1). Not being virologists, we can only speculate about the reasons behind this gap. Perhaps it simply reflects more testing, or maybe the new wave of infections mainly consists of young people, or perhaps this gap is due to the time lag between infections and deaths.

In any case, the second wave foreshadows more economic trouble ahead. It increases the chances that containment measures will be re-implemented and certain prefectures might even need to go into lockdown again. And even such local lockdowns will hurt the economy. For example, Tokyo and Osaka alone represents more than a quarter of Japan’s GDP, and new cases are surging in both regions. In addition (and perhaps more importantly), people will likely voluntarily impose social distancing rules on themselves. That means they will go out less, travel less and buy less, which will hurt consumer demand.

Industrial production grew by 2.7% q/q in June, which is better than expected, although still 17.7% lower than in June last year. Retail sales in June rebounded even stronger, namely 13.1% q/q (figure 2). That means our GDP growth forecast for Q2 was probably a bit too conservative. However, a possibly better than expected Q2 is likely to be offset by a weaker than expected Q3 and Q4. Rising cases in Japan (and in some of Japan’s major trade partners as well) will hold back the recovery as it hurts sentiment and demand. Therefore, we have revised our quarterly forecasts, but overall we still expect Japan’s economy to contract by 4.8% this year. The risks to our outlook remain clearly tilted to the downside.

Unemployment decreased a bit in June, to 2.8% from 2.9% a month earlier. However, the slight reduction in unemployment is more likely due to fewer people actively looking for jobs (which means they are not counted as being unemployed) rather than people being hired. Other indicators of the job market still point to weakness. The jobs-to-applicants ratio, for example, has continued to drop (1.1 in June) and still points to slack in the labour market (figure 3). Moreover, people seem to be concerned about their jobs. Data from Google Trends shows that Google searches in Japan for words such as “unemployed” and “find job” have spiked in the past few weeks to their highest levels in the past 12 months (figure 4). All in all, we still believe unemployment will rise to 4% in Japan this year.