Japan: From Underperformer to Outperformer

• GDP growth was much stronger than expected and Japan, for the second quarter in a row, was the strongest performing G7 economy. Significantly, private domestic demand improved substantially due to both the impact from fiscal stimulus programme and the sharp recovery in exports starting to spill over into domestic demand.
• Today's strong GDP data support our view of a very strong early recovery phase in Japan. Japan has mainly been hit by a collapse in external demand and as long as global trade continues to recover, Japan can be expected to perform strongly. Today's strong data question the consensus view that Japan will lag both Euroland and the Fed substantially in the monetary tightening cycle.

Bottom line

Japan's GDP growth was stronger than expected in Q3 and, for the second quarter in a row, Japan was the strongest performing among the G7 economies. Significantly, private domestic demand improved substantially, with both private consumption and business investment now showing solid gains. The improvement in private demand is both due to the impact from the previous government's fiscal stimulus programme and the sharp recovery in exports and industrial production starting to spill over into domestic demand. Industrial production is now up close to 25% from its bottom reached in early-2009 and although this is only about half of the output loss in the wake of the global financial crisis, this is starting to have a positive impact on both the labour market and capital expenditures.

Details

Despite a weak labour market private consumption grew by a healthy 0.7% q/q following a solid 1% q/q in the previous quarter (please see the table on next page for details). The biggest surprise in today's report was without doubt a surprising 1.6% q/q increase in private nonresidential. This suggests that business capital expenditure is currently bottoming out and has been in line with the improvement in domestic capital goods orders. Public investments surprisingly fell by 1.2% q/q in Q3. We expected continued improvement in public investments due to the impact from the fiscal stimulus package.

Just as in Q2 exports jumped 6.4% q/q in Q3. However, because of a substantial improvement in import volumes (up 3.4% q/q) net exports only added 0.4pp q/q in Q3 after adding 1.5pp q/q to GDP growth in Q3. According to the national accounts figures, inventories increased in Q3 and added 0.4pp q/q to GDP growth. It should be noted, that the monthly industrial inventory statistics in Japan have so far not shown an increase in inventories, despite the decline in inventories having slowed substantially.

Impact and outlook

Today's strong GDP data is consistent with our call of very strong early recovery phase in Japan. Growth in Japan has mainly been hit by a sharp contraction in exports and industrial production. After close to two decades of deleveraging household, corporate and financial balance sheets are in better shape than in Europe and the US and should weigh less on the recovery. As long as global trade continues to recover, Japan is expected to continue to perform strongly. Hence, we expect GDP growth to slow only slightly, to about 4% q/q AR in Q4. From early-2010 we expect a more substantial slowdown to around 2% q/q AR, as the global recovery in trade naturally loses some momentum and the impact from fiscal easing starts to wane.

In our view, today's strong data question the consensus view that Japan will lag both Euroland and the Fed substantially in the monetary tightening cycle. The current pricing in the market suggests the Bank of Japan (BoJ) will not hike until late-2011 (18 months O/N forward currently 0.15%, mid-price). So far Japan has recovered earlier and faster than Euroland and the US, albeit from more depressed levels. In addition it appears that the unemployment rate in Japan will peak in Q4 09 and the Japanese labour market will turn around before the US and Euroland.

To us this suggests Japan will not lag the monetary tightening process this time and we expect the BoJ to tighten in early-2010, only lagging the Fed and the ECB slightly.

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

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