Japan GDP skids in Q1, clouding BoJ rate hike plans

Japan GDP falls by 2% in Q1, clouds Bank of Japan interest rate hike plans

Japan's economy contracted more sharply than anticipated in the first quarter of 2024, as a persistently weak yen posed new challenges to the Bank of Japan's push to move interest rates further away from zero.

According to preliminary data from the Cabinet Office released on Thursday, the annualised Japan GDP figure fell by 2.0% in the January-March quarter, exceeding the 1.5% decline forecast by economists in a Reuters poll.  

This contraction follows barely any growth in the fourth quarter of 2023, after revisions primarily due to reduced estimates in capital expenditure.

Initial data on capital investment, typically prone to significant adjustments, highlighted broad-based declines across all GDP components, indicating a lack of major growth drivers in the economy during the first quarter.

This downturn comes at a delicate time for the Bank of Japan, which raised interest rates in March for the first time since 2007 and has indicated plans to continue tightening monetary policy.

Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities, told Reuters:

"It would be possible that the timing of rate hikes could be pushed back depending on how the GDP may rebound in the current quarter”.

He added that while the Japanese economy would certainly rebound in the current quarter due to rising wages, uncertainty remains around consumption in the service sector.

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Quarter-on-quarter Japan GDP falls by 0.5%

The Japan GDP figures translate to a quarter-on-quarter contraction of 0.5%, compared to the 0.4% decline expected by economists. Revised data for the first quarter will be available on June 10.

The weak Japanese yen seems to have created a two-speed economy, aiding Japan’s export and tourism sectors through a more competitive exchange rate while straining households and small businesses with higher costs for imported goods.

Daiwa Securities' Chief Economist Toru Suehiro noted the fall in the yen adds complexity to the Bank of Japan's decisions on whether to persist with or phase out its monetary stimulus:

"The adverse effects of a weaker yen are becoming a cause for concern so one can argue that interest rates should be raised. Although real wages are likely to turn slightly positive in the second half of this year, the level of real wages will not rise sharply as the yen continues to weaken."

Historic Japan wage hikes fail to keep up with inflation

Despite the largest wage increases in three decades by major Japanese corporations, which the Bank of Japan said provided the conditions needed to finally end its ultra-loose monetary policies, heightened living costs have led households to curtail spending, which in turn has eroded real incomes and purchasing power.

Private consumption, which makes up over half of the economy, fell by 0.7% — more than the 0.2% drop forecasted. This marks the fourth consecutive quarter of decline, the longest streak since 2009.

Economists remain optimistic that the first-quarter slump is temporary, expecting that the impacts from a recent earthquake and operational halts at Toyota’s Daihatsu unit will ease.  

However, continued sharp declines in the Japanese yen and potential spikes in oil prices due to the Middle East crisis loom as threats to Japan’s recovery.

Capital spending, crucial for private demand, decreased by 0.8% in the first quarter, slightly more than the 0.7% anticipated, despite strong corporate profits.

External demand, of exports minus imports, subtracted 0.3 percentage points off the Japan GDP Q1 estimates.

Policymakers are now pinning their hopes on substantial wage hikes and upcoming income tax reductions to rejuvenate consumption and stave off a return to deflation.

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Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.