Japan: Record Increase in Industrial Production in May

• Industrial production continued to grow at a record pace in May, suggesting GDP growth will rebound substantially. GDP growth is likely to turn positive this quarter and outperform the US and Euroland in H2 09.
• Retail sales were slightly weaker than expected but still suggest stabilisation in private consumption in Japan.

Details

Industrial production in May increased for the third month in a row and just managed to match the record increase in industrial production set in the previous month. According to productions plans, manufacturers plan to increase production by 3.1% m/m and 0.9% m/m in June and July, respectively, suggesting that the pace of recovery will slow substantially in the coming months. The recent rebound in industrial production is broadly in line with the recent strong performance in Japan's export volumes as seen in the chart to the right.

Inventories only declined marginally and apparently inventory cuts are easing despite the inventory/shipment ratio overall remaining elevated (see charts on next page). The inventory cycle is without doubt the most important driver behind the recent sharp increase in industrial activity in Japan. This is evident in the auto industry, where the gap between demand and supply has been most pronounced. Last month inventories in the auto industry declined to historical lows and in May the auto industry responded by increasing production by a whopping 34% m/m. The auto industry is planning to increase production further (see charts on next page).

As mentioned above, production plans suggest that the pace of recovery will slow substantially in the coming months. That said, the average increase in industrial production for the coming two months is still a healthy 2% m/m. However, it does raise the question about whether final demand will be able to sustain a continued recovery in industrial production when the inventory cycle has run its course.

There was some positive news from Japan's retail sales in May, despite coming in weaker than we had expected. Retail sales in current prices were unchanged in May following a healthy 0.7% m/m increase in the previous month. As seen in the chart to the right, there are currently clear signs of stabilisation in private consumption despite the weak labour market and the main explanation without doubt are the tax cuts currently being implemented as part of the first of Japan's two stimulus packages.

Assessment & outlook

The development in industrial production is consistent with our expectation of a sharp rebound in GDP growth above potential in the coming quarters. Japan's GDP growth is likely to outperform both the US and Euroland in H2 09 but it should be regarded mostly as a catch-up on the strong underperformance in Q4 08 and Q1 09, see Research - Japan: From underperformer to outperformer. We expect Japan's GDP growth to ease again in 2010. We think Japan's growth outperformance is likely to be temporary and we do not expect the Bank of Japan to hike interest rates before the Fed or the ECB and for that reason it is unlikely to have any significant impact on JPY.

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

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