Japanese economy contracted sharply in Q2

The Japanese economy contracted by 6.8% (annualized) in Q2, the steepest fall since the 2011 earthquake and Tsunami, according to data released by the Cabinet Office. The second-quarter decline more than wiped out the 6.1% gain posted in Q1.

The downturn was a consequence of the April 1 consumption tax hike from 5% to 8%, which dulled consumer spending.

Japan has the world’s largest budget deficit. In order to bring it down the government needs to increase revenue, hence the consumption tax rise.

More stimulus needed?

Economists predict that the severe economic downturn may force the government to take further stimulus measures.

The Bank of Japan (BoJ), however, says it has no plans to expand stimulus for the foreseeable future, adding that it is convinced GDP will grow.

BoJ governor, Haruhiko Kuroda, had repeatedly forecast a contraction in the second quarter.

A “quantitative and qualitative easing” measure was launched in April 2014. Japan’s central bank now purchases 70% of new government bonds issued in markets; a move aimed at reflating the sluggish economy.

GDP (gross national product) shrank by 1.7% compared to the first quarter, which posted a 1.5% quarter-over-quarter gain. Expansion in the first quarter had been expected as consumers stocked up on consumer goods ahead of the sales tax rise.

Toll of sales tax rise

Private consumption dropped by 5% in Q2 compared to Q1. Private consumption represents 60% of Japanese economic activity.

The consumption tax hike not only dampened retail sales, but factory output too.

Capital expenditure dropped by 2.5%, a figure that will worry policymakers who had been hoping that companies would help bolster the economy by spending more.

The Japanese government believes the economy will pick up during the second half of 2014. Akira Amari, Economics Minister, said after the GDP figures were published:

“Looking at monthly data during April-June, sales of electronics goods and those at department stores are picking up after falling sharply in April.”

“The job market is also improving steadily. Taking these into account, Japan’s economy continues to recover moderately as a trend and the effect of the sales tax hike is subsiding.”

Mr. Amari added that his government will make policy responses as necessary.

If the government prediction turns out to be too optimistic and the economy continues struggling, it is likely that Prime Minister Shinzō Abe may decide to delay the next sales tax hike (to 10%).

Reuters quoted Yuichi Kodama, an economist at Meiji Yasuda Life Insurance, who said “Should the next quarter be weaker than expected, there’s the chance that the BOJ will be called on to do some more easing – and how the BOJ responds then will be another point to watch.”

Exports disappoint

Mr. Abe’s administration had been hoping that a cheaper yen might lead to an export-led recovery. However, in real terms exports declined by 0.4% in Q1. A slowdown in the Eurozone and China messed up those predictions.

A large proportion of Japanese companies produce their goods abroad, which explains why the country’s automakers posted strong earnings, despite poor demand at home. Toyota Group sales rose by 2% in the last quarter.

On a more positive note, government data published on Monday showed that consumer confidence increased from 41.1 in June to 41.5 in July, the third consecutive month of improvement.

Japanese Consumer Confidence Index

(Source: Japanese Cabinet Office)

Investors optimistic

Investors had expected Q2 GDP to shrink more (7.1%) and said the results for the two quarters were normal – in Q1 the economy expanded ahead of the sales tax hike, while in Q2, after the tax rise, it shrank – the two have evened themselves out.

After the figures were published, the Japanese stock market rose by 0.3% while the yen remained virtually unchanged against the major currencies.

Investors also see a tightening labor market, which usually leads to higher wages and eventually increased household spending.

The Conference Board reported last week that the Japanese Leading Economic Index fell by 0.5% in June, as did the Coincident Economic Index, also by 0.5%.

Video – Japanese GDP shrinks sharply