April 1, 2015, 11:30 JST

Weak Tankan raises a question if more easing is required

March Tankan results were disappointing. It indicated that Japanese manufacturers are failing to fully restore the profitability back to the prevailing level before the  the sales tax hike in April last year. The business condition for large manufacturers remained flat in March at 12, lower than the recent peak of 17 in March 2014. By industry, it was disappointing to see no improvements in the business condition for electrical machinery and for car makers.

The picture is slightly better for non-manufacturers. The business condition for large non-manufacturers did improve from 17 in December 2014 to 19 in March 2015, while remaining below the height of 24 it reached in March 2014. By industry, it is encouraging to see marked improvements for real estates (improvement from 22 to 33), retails (-2 to 5) and personal services (18 to 27).  

BoJ Tankan is not just a sentiment number. As you could observe from the chart below, the level of business condition DI has a strong correlation with the level of corporate profits for the quarter. In this regard, it is quite disappointing that Japanese manufacturers seem to be failing to improve their profitability despite the sharp weakening in yen in the last 6 months. 

The sluggish tone of the BoJ Tankan should be a source of concern for the BoJ. For now, the BoJ maintains that there is no need for an additional monetary easing. While we agree, the dissapointing results from BoJ Tankan should give the BoJ a moment to ponder how long it can maintain such judgment. In our view, the combination of the monetary easing in October 2014 and the fortunate decline in commodity prices in the last 6 months should be sufficiently stimulative for the Japanese economy. The real effective exchange rate of yen is now at 40 year low, the weakest since 1972. However, if future incoming economic indicators continue to suggest little momentum for a stronger growth and a rising inflation pressure, we, as well as the BoJ, may need to reconsider. Not meeting the 2% inflation target in 2015 is perfectly defensible in light of the decline in commodity prices, but not hitting the target in 2016 may hurt the credibility of the BoJ without additional extenuating circumstances.  

Our judgement remains that the cost of an additional monetary easing outweighs its benefit, but we will need to reconsider such judgement if the next 3 to 6 months fail to give an indication that the growth and inflation momentum in the economy are visibly picking up.