Japan Outlook: Heading back to Square One

Our Forecasts

Headline Inflation

Risks to Our Views

Macroeconomic and Policy Dynamics

2023 would be the year when Japan see inflation treading slowly back to below average as supply chain restraints eases on global reopening, energy price rotating lower after the initial spike on Russian invasion and global central banks’ tightening policy filter into the system. Our revised forecast of 1.3% growth reflects the weaker private consumption caused by negative real wage and fading government stimulus effect. Despite consumer confidence having improved post COVID, household spending has been missing estimate since Q3 2022 as inflation growth start to outpace wage growth. Consumers are feeling the constraint in their budget as real wage is increasingly negative in Q1 2023 and the largest overall wage hike for three decades by 3.8% (base wage by 2.33%) will require months to take effect in household balance sheet. The fading impact of government stimulus would only provide a minimal level of buffer to the Japanese economy. Yet, domestic demand will remain the primary driver for GDP in the coming quarter and supported by the improving trade balance.

Figure 1: Japan CPI, CPI ex Food & Energy and Labor Cash Earning (y/y)

Meanwhile, the trade balance begins to show signs of improvement for global demand recovering and Chinese economic activity resumes after reopening. Japanese nominal imports had risen significantly over the past year on a rapidly falling value of JPY and exorbitant energy prices. Both have steadied and is expected to lower import growth. The latest Japanese export numbers shows improvement in the U.S. and Europe by double digits in percentage. Global demand for Japanese items is set to increase on a still soft JPY. Furthermore, another largest trade partner of Japan – China has exited the “Zero-Covid” policy and Chinese economic activities are expected to pick up in H2 2023, which will drive up the demand for Japanese goods. Although trade balance would not be improving significantly in H1 2023 as global demand needs time to pick up, Japan’s trade balance is expected to return to positive territory by Q3 2023.

 Japanese policymakers had shifted their rhetoric of inflation towards “achieving sustainable inflation” instead of focusing on any specific level as both the headline and core inflation have shot past the 2% target. Yet, the coming BoJ governor Ueda has stated that the BoJ would not revise the inflation target because it remains the best for Japan in a medium term. The BoJ has privately long viewed the 2% inflation target as a long shot because of the Japanese business culture does not favor passing cost to customers in fear of losing them and as low inflation expectations were so embedded. Now with headline inflation figure passing 4% (unsustainably in BoJ’s eye) and the BOJ has to purchase increasing amount of JGB’s to keep the lid on upper target band in the face  of rising global yields, it appears shifting the 10yr JGB cap is the most logical policy decision.  The headline CPI in January  slowed to 4.3%, though  ex-fresh food & energy CPI went past 3% to 3.2% and is expected to show signs of moderation in February. Fresh food prices remain the biggest inflationary factor but is starting to slow in 2023..  

The banking crisis in United States and Switzerland will be unlikely to affect the banking system in Japan given the structural difference between Japanese banks and others. Yet, the turmoil in the bond market may suggest underlying losses in certain Japanese banks and could affect Ueda’s decision in changing current policy and tools. There has been no demand for the funding operation from BoJ so far, that seems to suggest Japanese banks are in much healthier status. We expect the BoJ to keep a close eye to the matter but would not make major policy decisions because of the event.

The outlook for 2023 is a return to the “Japanese” pace of GDP growth and inflation when unsustainable factors fades. Growth has been revised to 1.3% as fiscal stimulus are almost fully filtered into the Japanese economy with private consumption limited by negative real wages throughout Q1-Q3 2023. Moreover, the Japanese government will switch from the current fiscal support package to long-term fiscal policy consolidation and thus government spending would account for a lower percentage in GDP growth in 2023/24. The Kishida government does not have the fiscal space to follow through to materially boost low-income households and reduce income inequality, though some increased taxes could be seen on the rich in the coming quarters.

2023 CPI will stay at +1.5% as the unsustainable inflationary factors will phase out and supply chain issue dissipates by H2 2023.. We also see an unwinding of 2022 inflation issues subtracting from inflation in 2024 as they are partially reversed. Therefore, we revised our inflation forecast in 2024 to +0.5%.

Policy Outlook

Inflation seems to have picked up compared to previous Japan historic inflation data trends in the last 20 years and would likely prompt Ueda to make changes to the YCC again yet not strong enough to normalize policy by hiking rates. We are forecasting Ueda to change BoJ’s forward guidance as soon as June, before revising 10yr JGBs upper target band to 0.75% for the Yield Curve Control tool at the September or October meetings. We do not see a hike in the deposit rate in 2023 because inflation will be returning to below 2% in 2023/24 and economic growth are is limited to sub 1%, neither are supporting for further policy normalization.  The BOJ would also be reluctant to make two major policy changes in Ueda first eight months.  

In 2024, we see no further policy changes from the BOJ, partially as the BOJ does not want too large unrealized losses in banks bond portfolios.  Additionally, we look for a low inflation outcome in 2024, which will be constraint to further BOJ policy normalization or amendments to QE with yield curve control.  

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