Overview: Data released during the Christmas break paint a very bleak picture of the Japanese economy. According to industrial production figures, Japan is currently experiencing the fastest deceleration in industrial activity since the Second World War in the wake of a near collapse in exports. Although we do see signs of some resilience in private consumption, we now believe GDP growth could contract by as much as 1.5% q/q in Q4 08 and there is an increasing risk that the Japanese economy will continue to contract in H1 09. Although we have already made some significant downward revisions to our GDP forecasts in recent months, we will soon have to make another major downward revision to our 2009 GDP forecast.
Details: Industrial production in November plunged 8.1% m/m following a 3.1% m/m fall in the previous month. This is the sharpest monthly contraction in industrial activity since Japan started recording monthly industrial production in the 1950s. Shipments of industrial goods dropped 8.4% m/m and production continues to run ahead of shipments (see chart 2). Despite the sharp cutbacks in production in recent months, inventories continue to increase and the inventory-sales ratio has soared to unsustainable levels (see chart 1). While one might be inclined to think that things cannot possibly get any worse after an 8% monthly drop in industrial production, it is likely to get a lot worse in the coming months. In December, Japanese manufacturers now plan to cut production by 8.0% m/m (in October a 2.9% m/m cut was planned) and in January an additional 2.1% m/m cut in production is planned (see chart1).
If industrial production in December turns out as planned (usually production plans are the most reliable indicator for actual production), industrial production will have contracted close to 20% during Q4 08! While it may be hard to comprehend such a sharp and fast deterioration in industrial activity, this development is actually consistent with the most recent manufacturing PMI (also released during the Christmas break) where both PMI production and PMI new export orders dropped to record lows (see chart 3 and chart 4).
The sharp drop in industrial production has mainly been driven by capital goods (-13.4% m/m in November), producer goods (-9.4% m/m) and cars (-11.8% m/m), while private consumption goods excluding cars actually performed quite well in November (see chart 5). Production of non-durable consumption was only down slightly (-0.3% m/m) and production of durable consumer goods excluding cars even recovered (+6.0% m/m) after having been weak since early 2008. Hence, Japan's industrial production is currently being hit particularly hard because of its dependence on capital goods and cars (close to 15% of total industrial production and more than 35% of consumer good production).
The resilience of durable consumer goods shipments (besides cars) in November supports our view that lower inflation is starting to have an impact on real incomes and private consumption. CPI inflation excluding fresh food in November dropped to 1.0% y/y from 1.9% y/y in the previous month (see chart 8) and real labour income growth has improved slightly in recent months despite the weaker labour market (see chart). Both real retail sales and real household expenditures recovered slightly in November (see chart 9) despite the overall horrible economic data for November. We continue to believe that private consumption will start to recover slightly in H1 09, when it will get additional support from tax cuts. However, for private consumption, H1 09 will be a tug of war between the positive impact from both lower inflation and taxes on the one hand, and negative employment and wage growth on the other hand. With the overall dismal November figures, there is an increasing risk that the weaker labour market will gain the upper hand.
Outlook: Based on the development in production plans and manufacturing PMIs, export figures for December are likely to turn out to be just as bad as the dismal November figures (see chart 4). If that turns out to be true, foreign trade has most likely subtracted more than 1pp from GDP growth in Q4 08. With private consumption expected to be broadly flat and business capital expenditure to have contracted considerably, GDP is likely to have contracted by close to 1.5% q/q in Q4 08. Currently we expect GDP to recover slightly in H1 09. However, with excessive inventories and danger of major layoffs in early 2009, there is an increasing risk that the economy will continue to contract in H1 09. Although we have been adjusting our GDP forecast downwards in recent months, we will soon have to make another major downward adjustment (possibly below -1% in 2009 from our current -0.7% forecast).
Impact: Because of the extraordinary weakness in exports, we might be witnessing a major shift in Japan's current account. It will be dependent on how well private consumption holds up. Some are starting to discuss the possibility of a current account deficit in 2009! This could eventually prove important for JPY. Obviously there is a lot of pressure on BoJ. There is not a lot it can do on interest anymore, so focus will be on new measures to implement some kind of quantitative easing.
Danske Bank
http://www.danskebank.com/danskeresearch
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