Official data published on 18/05/17 showed first-quarter growth in Japan of 2.2% quarter-on-quarter (QoQ) annualised. This was higher than expected and marked the fifth straight quarter of expansion in Japan's GDP. It's the longest consistent period of growth since the period between January 2005 and June 2006, when Japan enjoyed six consecutive quarters of GDP growth.
By most measures this pace of GDP growth is not especially impressive but it’s more than twice Japan's potential growth rate as the economy struggles with the impact of an ageing population and stagnant wages.
This economic recovery has taken years to arrive and comes only after trillions of yen in stimulus packages to counter deflation and boost growth. The Bank of Japan (BoJ) is of course still engaged in a number of unconventional policy measures (including 'Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control' - see Exhibit 1 below for a comprehensive review of the BoJ's policies).
Exhibit 1: An overview of the Bank of Japan's non-conventional policy measures and changes in key interest rates during the period between 01/01/2015 and 22/05/17Source: Bloomberg, as of 22/05/17
Japan's consumption rebounded from virtually zero growth in the fourth quarter of 2016, although in the absence of any gains in real wages, the trend does not look strong.
Despite a fall in Japan's unemployment rate to the lowest levels since the early 1990s salaries are not rising. It would appear that in order to avoid paying higher salaries Japanese companies are either hiring more part-time or temporary workers at lower wages.
Japan's growth data shows a distinct dichotomy between strong and supportive net exports (boosted by shipments of goods to Europe and the US where Japan is an important supplier) and weak domestic demand.
Investment growth slowed significantly, although that may be partly just quarterly volatility. Public investment growth is expected to raise ahead of the 2020 Tokyo Olympics.
The absence of wage growth in combination with the fact that core inflation, (excluding fresh food and energy), has slipped back into negative territory (see Exhibit 2 below) lead us to conclude that the Bank of Japan will not be making any changes to its monetary policy in the near term. It will continue the policy of targeting 0% for 10-year government bond yields.
Exhibit 2: Japan's core consumer price index (CPI) has slipped back into negative territory (the graph shows headline and core CPI in % terms, year-on-year from 2005 through 19/05/17)Source: Datastream, BNP Paribas Asset Management as of 22/05/17
As for Japanese equities, we think there are some positive factors. Valuations look relatively low and the earnings outlook and recent earnings momentum are also favourable. Monetary policy should stay supportive.
However, the equity market usually moves in line with the yen. In our main scenario, we see broadly the yen holding at current levels over the next 12 months. Meanwhile, Japanese equities have moved ahead of the currency, so we are reluctant to increase our allocation.
Written on 22 May 2017