Japan’s economy has fallen into a recession unexpectedly, with its GDP shrinking for the second consecutive quarter due to weak domestic demand. This decline has led to uncertainty regarding the central bank’s plans to exit its ultra-easy policy sometime this year. As a result, Japan has lost its title as the world’s third-largest economy, replaced by Germany.
The data released by the government shows that Gross Domestic Product (GDP) fell by an annualized rate of 0.4% in the October-December period following a 3.3% slump in the previous quarter. This decline comes as a surprise, as the market had forecasted a 1.4% increase. Two consecutive quarters of contraction meet the technical definition of a recession.
Analysts express concerns about the Bank of Japan’s forecast that rising wages will support consumption, thus justifying the phasing out of its massive monetary stimulus. Takuji Aida, chief economist at Credit Agricole, highlights the risks posed by slowing global growth, weak domestic demand, and the impact of natural disasters such as the New Year quake in western Japan. These factors could lead to further contraction in the economy.
Despite the weak data, the yen remained relatively stable, and the Nikkei rose by 1%, possibly on expectations that the Bank of Japan may prolong its massive easing program. On a quarterly basis, GDP slid by 0.1%, contrary to median forecasts of a 0.3% gain.
The data also reveals weaknesses in key sectors of the economy. Private consumption, which accounts for more than half of economic activity, fell by 0.2%, while capital expenditure, another significant growth engine, also experienced a decline. However, external demand, driven by exports, contributed positively to GDP.
The Bank of Japan has been contemplating ending negative rates by April and making changes to its ultra-loose monetary framework. However, given the lingering risks, it is expected to proceed cautiously with any policy tightening. The possibility of ending negative rates in March or April is widely discussed among economists, but some analysts believe Japan’s tight labor market and strong corporate spending plans may allow for an earlier exit from ultra-loose policies.
Marcel Thieliant, head of Asia-Pacific at Capital Economics, emphasizes the divergence between the GDP data and other economic indicators such as business surveys and the labor market. He predicts sluggish growth for the year ahead, with the household savings rate turning negative. Despite this, he maintains his projection that the Bank of Japan will end its negative interest rate policy in April.
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