Japan: Real progress with volatility

Japan: Real progress with volatility

Japan: Real progress with volatility

Global Economic Outlook Q3 2013

Abenomics’ effect on economic performance is temporary, as it is driven by movements in asset prices and a boost in business confidence. Long-term improvements will require real economic reforms.

GEO Q3 Japan

In Japan, it now appears that Abenomics is bearing some fruit in terms of a boost to economic activity. On the other hand, Abenomics has also created a far more volatile financial environment. Yet the improvement in economic performance can only be considered temporary as it is driven by movements in asset prices and a boost to business and consumer confidence. Longer-term improvements in economic performance will require real economic reforms—something that remains somewhat uncertain until there is a change in the political landscape.

The real economy

The most positive economic news came from Markit’s monthly purchasing managers’ indices (PMIs), which can provide a forward-looking indication of economic conditions. In June, the PMI for the manufacturing sector reached 52.3, the highest level in nearly 2.5 years. A reading above 50.0 indicates increasing activity. A higher number means faster growth. The sub-index for new orders was up strongly to the highest level in three years. However, new orders for exports were up only modestly, likely due to the continuing recession in Europe. Japan’s manufacturing PMI was also one of the highest among major economies. On the other hand, Markit reports that Japanese manufacturers face a profit squeeze because of rising import prices—itself the result of a declining yen.1 Markit’s PMI for the services sector was 52.1 in June, down from a record high of 54.8 in May.2

There was other good news recently: The government reported that industrial production increased 2.0 percent from April to May, shipments of capital goods were up 1.7 percent (suggesting a rebound in business investment), the inventory-sales ratio declined, retail sales increased 1.5 percent from April to May, and consumer prices stabilized after declining for six months. One reason for the stabilization of prices is that, with a declining yen, prices of imported energy rose.

Business sentiment is improving as well. Japan’s Tankan survey of business sentiment increased strongly in June, with the manufacturing survey rising to its highest level in more than two years. Evidently, despite increased financial volatility in the past month, Japanese business executives are confident that the new economic policy will bear fruit. The fact that the yen remains well below the peaks it reached last year has already had a positive impact on export competitiveness.

Finally, although consumer spending growth has decelerated from its rapid pace in the first quarter, spending on big-ticket items such as home-related products and automobiles continues to be strong. Consumer confidence is up considerably, and job market conditions have improved. And although nominal wages continue to fall, worker bonuses are up considerably, thereby contributing to increased demand for large expenditures.

Overall, it appears that Abenomics is bearing some fruit. A lower yen boosted competitiveness, an aggressive monetary policy boosted expectations of inflation, and a radical shift in policy boosted confidence. Yet for longer-term success, more reform legislation will need to be passed. Recent polls show that Prime Minister Abe remains quite popular. Shinzo Abe successfully consolidated his power in elections for control of parliament’s upper house, setting the stage for Japan’s first politically-stable government since the popular former prime minister Junichiro Koizumi left office in 2006. This means that the government can forge ahead on a range of issues and can more easily pass reform legislation.

One potential area of trouble for the government is the national sales tax. Based on legislation passed during the previous government, the national sales tax is set to increase next year. The tax will rise from 5 percent to 8 percent during the second quarter of 2014. This could have a severe negative impact on economic growth. It is meant to improve the country’s long-term fiscal position, setting the stage to pay for the rising cost of pensions and healthcare. Indeed, the tax is set to rise again to 10 percent in 2015. A senior government official now says that the government may consider boosting spending next year in order to offset the negative economic consequences of the tax hike.

Overall, it appears that Abenomics is bearing some fruit. A lower yen boosted competitiveness, an aggressive monetary policy boosted expectations of inflation, and a radical shift in policy boosted confidence.

A volatile June

Abenomics has a considerable impact on financial markets. Initially, the yield on Japanese government bonds dropped sharply as the government engaged in substantial purchases of bonds. The drop in supply meant that the price of the bonds increased (the yield declined). Recently, however, the yield bounced back when markets became concerned about actions by the Federal Reserve. Specifically, the Fed hinted that it will soon decelerate the pace of asset purchases. Consequently, US bond yields increased quickly, leading global investors to shift toward US bonds and away from non-US assets. In addition, investors started to anticipate higher inflation in Japan as a result of the Bank of Japan’s policy of asset purchases. This meant that investors required a higher return on bonds to offset expected inflation. Still, the increase in bond yields was not sufficient to offset the rise in expected inflation. As such, the real bond yield (nominal rate minus expected inflation) may have actually declined.

In addition, Abenomics initially led to a sharp increase in equity prices and a sharp drop in the value of the yen. Both had positive effects on economic activity and business confidence. Yet both were reversed in June during a period of volatility. Still, despite turmoil, equities remain well above the level prior to the election of Shinzo Abe, and the yen remains far lower.

One effect of the rise in Japanese bond yields has been a boost in mortgage interest rates. Interestingly, this rise in rates has coincided with a substantial increase in home buying as consumers decide to take advantage of relatively low mortgage rates before they get even higher. The rate on a fixed rate 35-year mortgage has increased from 1.8 percent in April to 2.0 percent in May. This is still very low. By comparison, the rate on a 30-year fixed rate mortgage in the United States is now 3.98 percent. The result of the increased demand for homes has been a rise in housing starts (up at the fastest pace since 1996), a rise in home prices, and a rise in land prices. Home buyers are particularly interested in fixed rate mortgages in order to lock in low rates. If rates rise much more, however, there could be a drop-off in home buying.

Financial market volatility in Japan has led to questions about whether the Bank of Japan will adjust policy or simply stay the course. After initially saying that nothing will change, BOJ Governor Haruhiko Kuroda said that the bank could add to the volume of asset purchases if economic conditions warrant. This is the first time he acknowledged that the policy is flexible.3 He had previously suggested that the policy was fixed and would not change based on changing economic circumstances. Specifically, Kuroda said that he doesn’t plan to change policy in the next two years, but he’s amenable to making changes if the country’s economic or financial situation deteriorates or if it becomes apparent that the policy is insufficient.

What next?

There are two important unknowns regarding Japan’s economy. First, we don’t know what specific reforms will be enacted as part of the third “arrow” of Abenomics (the first two being fiscal stimulus and aggressive monetary policy). Clarity about the reform agenda will help determine whether the progress so far is ephemeral or sustainable. Second, we don’t know what impact a radically new monetary policy will have on asset prices. Already, bond yields, equities, and the currency have been on a roller-coaster. But the general direction of these asset prices has been positive.


View all endnotes
  1. Markit Economics, “Press releases,” http://www.markiteconomics.com/Survey/Page.mvc/PressReleases, accessed July 17, 2013.
  2. Ibid.
  3.  Kihara, Leika, “BOJ’s Kuroda says will shift policy of economy changes,” Reuters, 2013, http://www.reuters.com/article/2013/06/19/us-japan-economy-boj-idUSBRE95I04U20130619 accessed July 19, 2013.


Dr. Ira Kalish

Dr. Ira Kalish is chief global economist of Deloitte Touch Tohmatsu Limited.

Global Economic Outlook, Q3 2013: Japan
Cover Image by Jessica McCourt