Japan: GDP Takes Another Dive in Q1

• GDP contracted by 4.0% q/q, the biggest quarterly decline in GDP ever recorded in Japan
• The main message is that the worst appears to be over and that GDP growth will improve significantly during the summer supported by fiscal easing, some improvement in exports and an end to the extraordinary destocking
• With signs that the economy is starting to improve Bank of Japan will be on hold. We expect no more new quantitative easing measures. However, with a considerable output gap and core inflation declining Bank of Japan is far from considering an interest rate hike.

Details

GDP contracted sharply by 4.0% q/q in Q1, which is the largest ever quarterly decline in GDP recorded in Japan. Since Q1 last year GDP has contracted by 9.7% y/y. The contraction in private domestic demand accelerated to 3.4% q/q driven by a larger-than-expected 10.4% plunge in corporate investments. Exports dropped a whopping 26.0% q/q, broadly in line with our expectations. The only ray of light in today's GDP numbers was that inventories are finally being cut. In Q1 lower inventories subtracted 0.3% q/q from GDP growth. See Q1 GDP, Japan for further details about today's GDP report

Assessment & Outlook

In Japan the main message is now that growth will pick up significantly during the summer. Fiscal easing will start to have an impact, exports have started to recover and production in the auto- and electronic industry will gradually be adjusted to demand following extraordinary low activity levels in recent months to cut inventories.

Just as Japan underperformed on growth during the downturn compared to Europe and the US, it is likely to outperform during the upturn. Hence, we believe confidence indicators and GDP growth will rebound stronger than in the US and Europe in the coming months. On the surface GDP will still look weak in Q2, when we expect 0.0% q/q growth, but this number will mask improving economic activity during the quarter. In Q3 we expect GDP growth to accelerate sharply to around 1.5% q/q and there could even be considerable upside to this forecast.

Despite the slightly weaker-than-expected Q1 and the downward revision of Q4 08 we do not expect to adjust our current -5.7% GDP growth forecast further down. In 2009 we currently expect GDP growth to be 2.9%, which is significantly above consensus.

Implications

Monetary meetings well become less eventful and more predictable. With signs of the economy improving there will be no quantitative easing initiatives from Bank of Japan (BoJ). The most exciting thing about the coming BoJ monetary meetings (including Friday's) will be to what degree it acknowledges signs of improvements in the economy. That said, we are far from a situation in which BoJ will remove its quantitative easing measures or even start to consider interest rate hikes. The output remains considerable until late next year and we expect core inflation to continue to decline and drop below -0.5% y/y in coming months.

For JPY the implications are less clear. We expect global manufacturing and global trade to continue to recover during the summer and the risk sentiment in the financial markets to continue to improve. In this scenario we expect JPY to weaken against USD. However, it cannot be completely ruled out that growth outperformance and bigger surplus on the current account could start to benefit JPY at some stage.

Danske Bank
http://www.danskebank.com/danskeresearch

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