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Reflections #44 - Japan: 6% GDP growth and BoJ still easing

Japan's Q2 2023 GDP growth came in at a whopping 6% (QoQ, ann), double the expectation of 3%.

The obvious questions are:

Is the Japanese economy in overdrive while the RoW slows down?

When is the BoJ finally reacting to higher inflation and activity?

While the headline growth of 6% qoq ann. looks indeed very strong, the details suggest this high number may rather be an outlier than a trend. Growth was exclusively driven by net exports (+7.2%), while domestic demand was a drag to growth (-1.2%).

Chart 1: Japan Real GDP growth (QoQ, ann)

The increase in exports is largely due to increased production and exports of automobiles supported by the easing of supply shortages of auto parts. It is highly uncertain - and probably unlikely that this is going to continue as the major economies are slowing down. Manufacturing indicators have eased in the major economies and are signaling a further decline in economic activity ahead. Hence, the strong export demand is likely to wane.

Chart 2: Manufacturing PMIs

On the other hand, real imports declined by an annualized 16.2% reflecting weak domestic demand. The weak domestic demand is supported by slowing imports of crude oil (see chart 3). Since Japan imports all its crude oil, lower imports are a strong sign of weak underlying demand.

Chart 3: Japan's imports of crude oil

So what does this mean for the BoJ?

At its last meeting, the BoJ only did a mini YCC tweak and left the policy rate at -0.10%. At first glance, this can hardly be reconciled with 6% GDP growth and CPI inflation at 3.3%.

However, the underlying weak domestic demand partly vindicates the ultra dovish stance given the worsening outlook for the major economies. Inflationary pressures are receding quickly. China's negative PPI and recent weaker activity numbers are worrying and turn the risk for inflation sharply lower (see chart 4).

Chart 4: China, Japan PPI and CPI

Nevertheless, despite the weak domestic demand and weaker outlook for exports, the Japanese economy is in a relatively favourable condition which does not warrant negative rates and YCC. Thus, it is quite likely the BoJ will have to adjust its YCC stance further even though the adjustment remains painfully slow with all its consequences for JGBs, JPY and global markets.

Bottom line, Japan's economy is lifted by strong exports while domestic demand remains weak. The strong boost may prove to be temporary given the slowdown in the rest of the world. The BoJ has missed another opportunity to get out of its ultra lose monetary policy but may ultimately be forced to adjust it again. Until then, the JPY will be driven by factors outside Japan and most prominently by US rate expectations.


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