While Japan continues enjoying government-led support measures, the slowdown in major emerging economies — in combination with ongoing fiscal challenges in OECD economies — is putting some strain on the most recent expansion. Industrial production fell the most in more than two years in June on a monthly comparison. On the other hand, machinery orders increased significantly in May, pointing to a potential continuation of output growth in the coming months, though it should not be overlooked that most of the increase in orders came from domestic sources, hence underscoring the importance of local stimulus measures for the potential recovery. The positive trend is also visible in the latest Tankan survey, one of the key business sentiment surveys in Japan, which is provided by the Bank of Japan (BoJ). The Tankan’s forecast reached 10 index points in its latest quarterly release at the beginning of July. This is the highest level since the first quarter of 2008. However, this is based on a very positive mood in the economy, which was particularly heightened after the BoJ announced its broad and unprecedented monetary stimulus in April and the government followed with additional announcements about structural improvements in the economy. The Tankan index level of actual conditions has performed positively as well, but seems to reflect a more reasonable perception. It reached 4, the highest level since 1Q11, just before the triple disaster of March 2011. Another leading indicator — the PMI — points at slightly weaker development. The latest PMI for manufacturing fell back to a level of 50.7 in July from 52.3 in June.
Monetary stimulus, in combination with the other two arrows of the government’s growth strategy — fiscal stimulus and the structural improvements — are all expected to put a floor on this year’s growth rate in particular and to some extent on next year’s expansion. The latest discussion about planned sales tax increases has highlighted that the government’s fiscal ability is limited, given its record debt pile. However, it will be of great importance to adjust debt levels to more reasonable ratios. Therefore, the central tool for stimulus will be monetary policy, supported by structural efforts, while fiscal support will be limited and very specific.
This fiscal drag is already expected to become visible in the next year, when the consumption tax increase is forecast to impact growth patterns in 2Q14 and 3Q14. The consumption tax rise is planned to take place in two steps. It will be increased to 8% by 2014 and to 10% by 2015, from its current amount of 5%. It should also be noted that raising the consumption tax might turn out to be a risky move. In 1997, the last time the tax was increased, it led to a recession and a slump in retail sales, and to a steep decline in central government tax revenues. The cabinet office itself has released a forecast of only 1.0% GDP growth for the fiscal year 2014–2015 if the planned sales tax increase is implemented.
So far inflation has improved significantly, but remains much below the targeted level for next year of 2%. While it fell by 0.3% y-o-y in May, it rose by 0.2% in June. The yen also performed relatively well at around ¥100/$ in July. Consequently, the latest export numbers continue to be encouraging. Exports in June increased by 7.4% y-o-y, only slightly below May’s number of 10.1% y-o-y. Retail sales also continued to rise in June by 1.6%, after May’s increase of 0.8% y-o-y. On the other side, industrial production fell significantly on a monthly base in June by 3.3%. The slight slowdown in the economy also led to a lower consumer confidence index level, which declined to 43.6 in June from 45.5 in May, based on numbers provided by the Cabinet Office. The positive momentum from 1Q13, in combination with ongoing support measures, has caused an upward revision of GDP expectations for 2013; from 1.8% to 1.9%. While growth for the current year is relatively well-established, the potential for next year remains to be seen. The consumption tax increase is expected to heavily impact 2Q14 growth, which is now projected to be flat, after an expected significant rise in 1Q14 ahead of the tax rise. Taking into consideration this negative impact and its continued drag for the remainder of the year — and also some slower underlying momentum in 2014 — the economy’s growth forecast for 2014 remains at 1.4%.