Weekly Economic Briefing

Fingers crossed

17 January 2017

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On the face of it, there is much to be optimistic about Japan in the Year of the Rooster. The pick-up in the global cycle and the recovery in sentiment as the yen retraced some of its early 2016 strength bode well for a robust rebound in growth. We have pencilled in a 1.1% year-on-year expansion in activity in 2017, far in excess of potential growth, which remains closer to 0.5%. However, for us to really get enthused, we need to see the domestic growth engines fire more consistently.

Waging war
Real sector unstable

Given private consumption accounts for 60% of GDP, the outlook for real incomes remains an important consideration. In terms of wage growth, the main focus will be on the Shunto wage negotiations, with the base pay component to be most closely watched. After three solid years of growth, the omens for 2017 are less favourable (see Chart 7). Wage-setting convention dictates that prevailing inflation and profit trends will steer decision-making. With core CPI having been negative for much of the last 12 months, and operating profits forecast to be 8.1% lower in FY2016 than the previous year, the outlook does not look favourable. There is a strong case to discount these factors due to the distortions from energy price and currency trends, especially as labour market conditions measures point to skill shortages in key sectors, but that would require an unusual degree of pragmatism. Of course, aggregate incomes at an economy-wide level can improve if employment continues to trend upwards. However, there are signs that employment growth is actually topping out, while hours worked remain on a downward trend. Furthermore, household real incomes may come under threat from a return to import-cost inflation in the event that the yen weakens further.

The corporate sector clearly has less to fear from yen depreciation, and the post-Trump and Republican election weakness has fed through to an improvement in sentiment. Indices of industrial production and export data have been robust, setting a solid base for capex in 2017. For investment trends to really take-off, corporates must upgrade their own growth expectations. As a reminder, the corporate sector’s growth outlook is still below the level before Abe came to power in December 2012. Unfortunately, the most recent extraordinary Diet session was something of a legislative disappointment, with significant political time and capital expended on passing the TPP and Pension Reform bills. By contrast, there was little progress on labour market reform issues such as work-hour deregulation and dismissal compensation. Of course, monetary and fiscal policy remains extremely supportive and the government may continue to dangle carrots to induce investment. However, the government has yet to deal with a more fundamental problem: the instability of the business cycle. Indeed, looking at a proxy measure of the business cycle it is clear that the most powerful drivers of activity in recent years have been financial factors, most prominently arising from currency fluctuations. By contrast, the real economy appears to lack a sustainable impulse other than external demand – making corporate decision-making more difficult (see Chart 8). Despite these worries, we should not downplay the importance of a global cyclical upturn. The country appears relatively well placed to benefit from a US-led growth surge.

Govinda Finn, Senior Japan Analyst

 
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