Japan unexpectedly slips into recession, Germany now world’s third-biggest economy

Japan unexpectedly slips into recession, Germany now world's third-biggest economy

Japan unexpectedly entered a recession in the final quarter of last year, surrendering its position as the world’s third-largest economy to Germany. This development has raised uncertainties regarding the timing of the central bank’s departure from its longstanding ultra-loose monetary policy. Analysts caution that the current quarter may witness another downturn, fueled by weak demand in China, sluggish consumption trends, and production disruptions at a unit of Toyota Motor Corp, which collectively pose significant challenges to Japan’s economic recovery.

Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute, highlighted the concerning sluggishness in consumption and capital expenditure, which are crucial components of domestic demand. The economy, he noted, lacks momentum without clear drivers of growth. Japan’s Gross Domestic Product (GDP) contracted by an annualized 0.4% in the October-December period, defying market expectations of a 1.4% increase and marking two consecutive quarters of decline, meeting the technical definition of a recession.

Despite expectations for the Bank of Japan (BOJ) to gradually unwind its massive monetary stimulus this year, the dismal economic data may cast doubt on the central bank’s projection of sustained consumption supported by rising wages, aiming to maintain inflation around its 2% target. Stephan Angrick, senior economist at Moody’s Analytics, emphasized the negative implications of consecutive GDP declines and domestic demand contractions, suggesting that these factors would complicate the BOJ’s plans for interest rate hikes.

Economy Minister Yoshitaka Shindo underscored the imperative of solid wage growth to bolster consumption, acknowledging the lack of momentum in this regard due to escalating prices. However, he emphasized that the BOJ considers various data points, including consumption trends, and economic risks when determining monetary policy.

Following the release of the data, the yen remained stable, while Japanese government bond yields declined as traders revised expectations of an imminent BOJ policy shift. The Nikkei stock average rallied to 34-year highs, reinforced by the BOJ’s assurances of sustained low borrowing costs even after the cessation of negative rates.

Private consumption, a significant contributor to economic activity, contracted by 0.2%, contrary to market forecasts, as rising living costs and unseasonably warm weather deterred spending on dining out and winter clothing. Similarly, capital expenditure, another vital driver of growth, declined by 0.1%, marking the third consecutive quarter of contraction.

Despite optimistic projections by large corporations regarding capital expenditure growth, actual investments face delays due to escalating raw material costs and labor shortages. Moreover, the latest machinery orders data, a leading indicator of capital spending, exhibited a contraction in November, casting doubt on the BOJ’s expectations of robust investment driving economic growth.

Amid speculation about the BOJ’s departure from negative interest rates, many market participants anticipate this move in either March or April, as highlighted in a Reuters poll conducted in January. While tight labor market conditions and robust corporate spending plans provide some support for an early exit from ultra-loose monetary policy, uncertainties persist regarding the pace and timing of such adjustments.