Monday, 28 April 2008

Japanese data reverse, economy pauses

Earlier reports of the demise of the Japanese economic expansion appear to have been exaggerated. Nevertheless, the outlook for the Japanese economy remains lacklustre.

On 7 April, I had written that Japanese industrial production had fallen for a second consecutive month in February and suggested that the Japanese economy could be contracting (see "Japan looking like the US, US looking like Japan").

That turned out to be a false alarm. The industrial production data were subsequently revised along with a change in the base year from 2000 to 2005. The revised data show that industrial output rose 1.6 percent in February. With this reversal and output projected to rise further by 0.2 percent in March, industrial production is now projected to increase by 0.5 percent in the first quarter.

Nevertheless, it remains true that industrial activity appears to be softening in Japan. The NTC Research/Nomura/JMMA Purchasing Managers Index had fallen to 49.5 in March from 50.8 in February.

Furthermore, the Bank of Japan's Tankan survey in March had shown that the diffusion index for large manufacturers had fallen to 11 from 19 in December. The index has now clearly peaked and is on a clear downtrend. In the past, this has usually been followed eventually by a contraction in industrial production.

Other sectors of the economy are also showing signs of weakness.

The tertiary index, which measures activity in the services sector, fell 1.7 percent in February mainly due to lower spending on financial and insurance services. The fall dragged the all-industries index down by 1.4 percent that month.

The boost to the economy from exports also appears to be diminishing. Exports rose just 2.3 percent in March from a year earlier, the smallest increase since May 2005. Exports to the US fell 11.0 percent. The slower export growth resulted in Japan's trade surplus shrinking 30.2 percent from a year earlier as imports rose 11.1 percent mainly on the back of higher energy prices.

Higher energy prices were also the main driver of higher Japanese consumer prices. Core consumer prices, which exclude fresh food, rose 1.2 percent in March from a year earlier, up from 1.0 percent in February. Excluding food and energy, prices were up just 0.1 percent.

There was one positive economic report last week. The index of leading economic indicators for February showed a revised 54.5 reading, the first time in seven months that the index had moved above 50, indicating that the economy is likely to expand over the next few months.

In addition, the drag on the economy from falling housing activity appears to be diminishing. Data released at the end of last month had shown that housing starts were down just 5.0 percent in February after having declined sharply for much of 2007 following a revision to Japanese construction regulations.

Nevertheless, the Japanese government remains concerned about the risks to growth, noting in its April economic assessment that the "economic recovery appears to be pausing". It warned of downside risks to the Japanese economy arising from the risk of a recession in the US economy, fluctuations in financial markets and oil price trends.

No doubt, those factors will be among the ones that officials from both the Bank of Japan and the Federal Reserve will be most focused on when they meet later this week to determine monetary policy. The latter is expected to cut interest rates by another 25 basis points. Many think it will be the last rate cut for some time to come.

However, with downside risks to the global economy still evident, we could instead see the Bank of Japan making its first rate cut in some time in the not-too-distant future.

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