Japan: Another Record Plunge in Industrial Production
Several important Japanese indicators were released overnight including industrial production, unemployment rate and inflation (see below for details). The releases make horrible reading. Japan is currently witnessing its sharpest-ever contraction in industrial activity and with few signs of stabilisation it seems set to continue until at least the end of the current quarter. In addition, the labour market is now weakening fast and increasingly weighing on private consumption. Inflation is declining fast and should return to negative territory by the end of the current quarter. While this is not necessarily negative from a demand perspective, there is a real danger of Japan being pushed back into destructive deflation. We are lowering our GDP forecast for Japan for 2009 from -1.5% to -2.6%.
Industrial production in December plunged 9.6% m/m (consensus: -8.9%) following an 8.5% drop in industrial activity in the previous month (see chart 1). Since the peak in February, industrial production has declined by 23% and sadly is likely to contract further. Inventories in December increased for the fourth month in a row (albeit at a slower pace) and the inventory-sales ratio is at an all-time high (see chart 1). In addition, production plans for January were revised sharply lower from -2.1% m/m to -9.1% m/m and manufacturers expect another 4.7% m/m decline in activity in February.
The unemployment rate in December jumped to 4.4% (consensus: 4.1%) from 3.9% in the previous month and the decline in employment has accelerated with total employment down about 1% y/y (see chart 4 and chart 5). The weaker labour market is apparently starting to have an impact on private consumption. Real household spending in December declined 4.6% m/m (consensus: -3.6% m/m).
CPI excluding fresh food in December declined slightly more than expected to 0.2% y/y from 1.0% y/y in November. The decline in inflation was driven mostly by the impact from lower energy prices, as CPI inflation excluding food and energy (core inflation) in December was unchanged at 0.0%. However, the preliminary January figures released for the Tokyo area showed a sharp drop in core inflation to -0.2% m/m from 0.2% m/m in December. This is an indication that we going to see strong downward pressure on core inflation in the nationwide figures in early 2009.
We are revising our GDP forecast for Japan further down. We now believe GDP will contract by 2.1% q/q and 0.8% q/q in Q4 08 and Q1 09, respectively. We have lowered our GDP forecast for 2009 to -2.6% from previously -1.5% (see details in table on page 2). First, the negative impact from the decline in exports will be larger than previously assumed. Based on the bad December trade figures we now believe foreign trade has subtracted about 2.0pp from GDP growth in Q4 08. Second, with continued inventory build-up, the need to cut inventories will be a significant drag on growth in H1 09. Third, we now believe that private consumption will contract in Q4 08 and Q1 09 because of the weaker labour market and a delay of the expected positive impact from the fiscal stimulus package that is currently stalled in the Diet. We still expect a boost to private consumption from tax cuts later in 2009.
Because of the extraordinary bleak outlook for growth, there will be increasing pressure on the BoJ to turn to some kind of quantitative easing. The BoJ has already started on this path by purchasing commercial papers and possible corporate bonds. While weaker external demand and not a stronger JPY is the main explanation for the recent weakness, further appreciation of JPY will obviously be unwelcome in this scenario. If appreciation of JPY continues, it will at some stage have to be met by a strong policy response: most likely boosting JPY liquidity by aggressive quantitative easing and possibly even intervention in the FX market.
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