Japan Outlook: Beginning of A New Era?
Bottom Line:
- GDP growth for 2024 has been revised lower to +0.8% as private consumption will remain in contraction in Q1 2024 as the Japanese economy continue to face inflationary pressure. We forecast consumption to gradually recover throughout the rest of 2024 when real wage turns positive. Consumption growth in 2025 will only grow modestly after BoJ move away somewhat further from ultra-loose monetary policy. The trade balance in 2024 would be solid with exports benefiting from soft JPY and less domestic demand driven imports, before returning to neutral for GDP in 2025. Government spending steadies throughout 2024/25 as the Japanese government’s fiscal room is limited.
- We are forecasting the BoJ to tighten the key policy rate by another +0.1% in June 2024 after exiting negative interest rate in March 2024. While BoJ’s forward guidance suggest accommodative condition will stay and signal no urgency in tightening, we believe the BoJ is likely to hike by the end of Q2 2024 to tame short-term wage growth driven inflation.
- However, the CPI inflation trend is likely to surprise on the downside in H2, from the lagged effects of the consumption slowdown. While Japanese business begun to demonstrate changes to price setting behavior, the lower PPI and customers’ reluctance will limit the magnitude of price increase and suggests less feed through to CPI than BOJ forecast. This makes a June hike a short-term balancing move for wage hikes and likely mean that the terminal policy rate could be as low as 0.1%. Yield Curve Control is removed but BoJ unlikely to tolerate spike in yields, though will allow a gradual rise in 10yr yields above 1%.
Forecast changes: We revised 2024 GDP lower to +0.8% from +0.9% because private consumption is now expected to contract in Q1 2024. 2024 CPI is revised higher to +2.1% from +1.7% to address the stronger wage hike Japanese unions secured.
Macroeconomic and Policy Dynamics
Japanese headline inflation is going to move back down to 2% throughout 2024 with the BoJ exiting ultra-loose monetary policy and entering positive interest rate era. Preliminary results from spring wage negotiation has seen larger hikes than 2023 with an average of 5% pay increase and up to 6.25% in total pay. Final wage negotiation result will likely see a downward revision from that number but still the result is sufficient to bring real wage into positive territory. Albeit consumption is expected to face headwinds in Q1 2024 (household spending was -6.3% y/y in Jan 2024), but the strong wage increases will slow but not stop the decline in inflation throughout the rest of 2024. Thus, our 2024 inflation forecast are revised higher to +2.1% from +1.7% and 2025 inflation to +1.1% from +0.8% as wage growth filters into the economy. CPI all items less fresh food and energy will ease at a slower pace. BoJ sees CPI less fresh food to be +2.4% (2024), +1.8% (2025) and CPI ex fresh food & energy be +1.9% (2024), +1.9% (2025).
As private consumption remains pressured by negative real wages in Q1 2024, our forecast for 2024 GDP growth softens to +0.8%. 2025 GDP is forecast to be +1.1% on normalized economic growth from more balanced wage/inflation dynamics. Private consumption is expected to gradually rebound in Q2 to Q4 2024, supported by real wage turning positive, before returning to modest growth in 2025. Headline labor cash earning had reached 2% in January 2024 before the strong wage negotiation result. Government spending will be steady given the limitation in fiscal space and we are not forecasting another round of stimulus.
The solid trade balance, benefiting from weak JPY and domestic demand, should provide a level of support to Japanese economic growth in Q1/2 2024. Japanese Export has increased by 9.9% y/y (in real terms) while import decreased by 4.7% in the first two months of 2024, exacerbating the headline trade balance. Even if domestic demand picks up and JPY strengthens after Q2 2024 and BoJ’s policy shift, we forecast the trade balance to stay positive in the remaining of 2024.
The trade balance continues to surprise to the upside and will remain a significant contributor for Japanese real GDP growth in H1 2024. Soft Chinese demand since China’s re-opening has been a drag to Japanese trade but we are seeing encouraging signs. Japanese export to China turns positive (9.6% y/y) for the first time in thirteen months in December 2023 and accelerated in January 2024 (+29.2% y/y). Exports to Asia, U.S. and E.U. are all upbeat with double digits y/y growth due to stronger than expected global demand and soft JPY.
Private non-residential investment has also grown by +1.9% y/y (in real terms) in 2023 despite steep inflation. The strong CAPEX has been cited by BoJ’s Ueda as a key reason to support his decision in changing monetary policy. With CPI further moderates and corporate tax breaks in 2024/25, investment should continue to grow and supports Japanese economy.
BoJ has revised their inflation forecast in January for y/y CPI less fresh food from +2.8% to +2.4% for 2024 and from +1.7% to +1.8% for 2025 but kept y/y CPI less fresh food & energy at +1.9% for both 2024 and 2025. BoJ has privately long viewed the +2% inflation target as a long shot because business culture in Japan does not favor passing cost to customers but such pricing behavior is changing in face of high input prices in the past two years (Figure 2). Moreover, another historic wave of wage hike is about to come and have persuaded the BoJ that the 2% target would be achieved in a sustainable and stable manner.
The biggest inflationary factor, fresh food and energy, moderates further and is not expected to resume the COVID era inflation as supply chain normalize and global food prices are soft. The National y/y CPI has inched closer to 2% at 2.2% in January 2024 but is expected to rebound in February as durable goods led a jump in Tokyo y/y CPI to 2.6% in February 2024 from 1.8% in January 2024. In 2024, headline CPI is forecast to be +2.1% as global disinflation stays on its course with PPI falling below 1% y/y growth in the past four months while the accelerated pace of wage hike after the latest wage negotiation may push up prices in a short run. By 2025, it is expected headline inflation would revert to the traditional Japanese pace of 1.1% after the BoJ exit negative rates and wage growth slows by consumer not willing to pay higher prices and then wage growth slowing down again.
Policy Outlook
The BOJ has left the era of negative interest rate and brought short term interest rate to the range of 0 and +0.1% after stronger than expected wage negotiation in March 2024 and CPI stays above 2% for all three categories. The BoJ also announced the end of Yield Curve Control but for now is going to continue buying roughly the same amount of JGBs as before and ready to intervene when yields spike. However, we feel this is only multi week forward guidance and the BOJ will likely slow net purchases to very low level by H2 2024, about the same pace as 2010-11. BoJ will allow yields to slowly go up but any spike or reaching 2% will be met with intervention. They will stop purchasing ETFs, REITS immediately and corporate bonds gradually within a year. However, it is worth noting that Ueda has hinted that the BOJ could reduce ETF holdings in the future and QT could start with Japanese equities.
With preliminary wage negotiation suggests strong wage growth, we believe the BoJ will likely hike by another 0.1% to bring short term interest rate to the range of +0.1% and +0.2% in June. The room for further tightening will be limited as we forecast CPI to move below 2% in Q4 2024 and we do not see more tightening in 2024/25. The key is that consumer will restrict attempts by companies to increase prices and this is likely to squeeze corporate margin growth in H2 2024 and then mean that companies settle for less wage increases in 2025! It is possible that the BOJ hikes the key policy rate in H2 based on wage growth alone and a desire for normalization. The failed normalization attempts in 2000 and 2006 show that the BOJ can go too far and then end up reducing the policy rate.