September 11, 2017

Japan is likely to continue feeling the unfavorable effects of low inflation and low consumption, despite strong labor force gains. Compared with the global economy, which is showing considerable resilience in the face of geopolitical and domestic political risks, Japan is facing a question of endurance. Inflation remains stubbornly low and seems unlikely to pick up sharply even if the growth outlook improves, while further labor force gains (and a very low unemployment rate) also do not appear to be translating into stronger consumer spending, with supermarket sales flat in July and department stores falling.

Muted inflation outlook remains

Japanese headline consumer price inflation was 0.4% YoY in July, unchanged from that of June. Food inflation eased to 0.6% in July YoY after from 0.8% a month ago. Utilities prices rose by 4.3% in July, up from 0.8% in June, but the effects of this were offset by negative inflation in housing (-0.2% YoY) and household goods (-0.4%). Excluding fresh food, core inflation crept up slightly to 0.5% YoY in July from 0.4% a month before. Inflation ex-fresh food and energy also rose to 0.1% YoY after being flat in the preceding months.

Tuan Huynh, CIO APAC and Head of WD APAC, Deutsche Bank Wealth Management, said, “Reflation continues only very gradually and should be supported in future by an improving growth outlook, but any momentum is likely to be limited. Base effects are likely to be more unfavorable going forward, and the Bank of Japan’s 2% inflation target still seems a long way off.”

Solid labour market

Japanese employment data remained solid in July. The labor force added 150,000 workers, 140,000 of whom were employed, which continued a trend of 120,000 employment gains seen in June. The job-to-applicant ratio increased slightly to 1.52 from 1.51 a month ago—a 43-year high. The unemployment rate remained at a multi-year low of 2.8%. However, labor force participation fell slightly to 60.8% from 61% in June.

Huynh commented, “A tight labor market does not appear to be translating into stronger consumer spending. Supermarket sales remained flat in July, after falling by -1.2% YoY in June. Department store sales also fell -1.4% YoY in July after rising +1.4% in June.”

Accommodative policy stance

At the Jackson Hole meeting last week, the Bank of Japan (BoJ) Governor, Haruhiko Kuroda, pledged to continue with the current very accommodative monetary policy stance “for some time” because of low inflation.

Huynh noted, “Kuroda sees a slower rate of GDP growth going forward, while the price situation lags behind other developed markets such as the U.S. In particular, Kuroda has previously noted that Japanese businesses and labor unions still exhibit a “deflationary mindset,” which is crimping price gains.”

During a Bloomberg interview, Kuroda said that the market for Japanese government bond (JGB) market was “functioning quite well”, arguing that the reduced number of bonds in the market meant that, over time, fewer JGB purchases would be needed for yield curve control purposes.

Japanese yen

The JPY strengthened as investors flowed into the “safe haven” currency following the latest North Korea missile test. Huynh said, “While geopolitical concerns may be supportive of the JPY in the short term, we expect stronger relative economic growth in the U.S. and rising interest rates to eventually push the USD higher vs. the JPY.”