September 30, 2014, 17:00 JST

Consumers on its mend in Japan

Judging by the flow of economic data released on September 30, the Japanese economy seems to have regained some balance in August. Retail sales rose by 1.2% year on year (YoY), marking the second consecutive month with a positive growth rate. While the moderately positive growth rate means that the real level of consumption after deducting inflation is still down from a year ago, the upward momentum in the last two months gives a hope that the consumption may be on its mend.

 Source: METI, JMA.

The labor market in Japan is striking the right balance. Aside from the news that the unemployment rate fell back to 3.5%, we consider the stable job offer to applicant ratio to be of particular good news for Japan. The effective job offers to applicant ratio in August was 1.10, continuing to hover at its highest point since 1992. In our view, the current level is just high enough to generate an adequate upward pressure on wages, but not too high as to cause severe labor shortage.

 Source: MHLW, JMA.

Wage inflation continued to warm up in August. The regular wage, consisting of basic wage plus overtime wage, rose by 0.7% year on year, maintaining its slow but consistent rate of acceleration. The pace of the year on year rise is still insufficient to compensate for inflation, but it has come a long way from the days when wages fell year after year. Between 2000 and 2013, wages in Japan were on a declining trend, falling by 7% in total. If Japan manages to make 2014 as the year when wage finally bottomed out, it would be a remarkable achievement in its fight against deflation.

 Source: MHLW, JMA.

So all is well and a relaxing time for policy makers? Of course not. While the direction of the economy in August seems to be on the right track, Japan’s fight to eliminate deflation is far from over. The consumption may be recovering from its funk after the sales tax hike, but it would be wrong to assume that the consumption can continue to expand while carrying the burden to pay higher sales tax rate both in 2014 and in 2015. If the Japanese economy is to maintain even a moderate growth in 2015, other demand components such as export or private capital expenditure need to start growing. On this front, the evidence points to disappointing conclusions. Far from being the promising source of demand, the manufacturing sector in Japan is experiencing a technical recession. In the past 5 months since April, industrial production has declined by 6.6%. Even worse, inventory kept accumulating, suggestion that the manufacturers may need to cut their production even further.

 Source: METI, JMA.

In our view, the current state of the Japanese economy seem quite fragile to a downside shock, not so dissimilar to its state before the sub-prime debacle in 2007. In 2007, Japan was also seen to be finishing off its transition out of deflation. The BoJ was already in the process of normalizing its monetary policy. As we know, instead of eliminating deflation, Japan had to suffer another few years of severe deflation and it took a large sized monetary and fiscal expansion to bring Japan back to the current state. If Japan suffers another setback, we are not sure if Japan can go through another fiscal and monetary expansion without triggering a fiscal crisis. In our view, Japanese policy makers needs to remain proactive to make sure that Japan does make it to the finish line to end its era of two lost decades. In our view, bringing inflation in Japan up to 2% cruising speed is crucial and its should happen soon before the fate deals another blow of Japan's economic cycle. 

With the recent yen depreciation, some economists argue that there is no need for the BoJ to take easing actions in the immediate future. We do not agree. In our view, the accommodative stance by the BoJ has in fact retreated somewhat in the first half of 2014. The lack of clarity on how long the quantitative easing would be sustained has created a suspicion that the BoJ may be thinking of drawing down on its monetary expansion even as early as in 2015. In our view, the BoJ should dispel such uncertainty. The first step the bank should take would be to publish its end-2015 balancesheet outlook in its October 6-7 meeting to clarify that the current pace of asset purchase would continue throughout 2015. The BoJ now owns 24% of Japan's public debt, up from 10% before the Kurodanomics started, and the temptation on the part of the BoJ to maintain its policy discretion is understandable. However, this is no time for wavering. With the shock of another consumption tax rate hike hitting the economy toward the end of 2015, the market need reassurance that the BoJ is indeed willing to do what it takes to maintain the current growth path and achieve its inflation goal of 2%. 

 Source: BoJ, MoF, JMA.