Japan's GDP Growth Slows as Consumption, Exports Slacken

TOKYO—Japan's economic growth slowed sharply in the second quarter, coming in well short of expectations as stagnant consumption and flagging exports weighed on an economy already hobbled by deflation and a soaring yen.

The data add to widespread concerns that Japan's fragile economic recovery may be running out of steam as growth in key export markets also slows. The weak numbers also come just as China looks set to overtake its east Asian neighbor as the world's second largest economy.

But it also comes as Japan faces pressure to tame its massive public debt, making new government stimulus efforts unlikely for now.

The economy could face a critical test in coming months, analysts said, as existing shopping incentives and other stimulus programs expire, removing what has been a crucial crutch. Meanwhile, the strong yen could put further pressure on Japan's key exporters, which are less competitive in other markets when the currency rises.

Real gross domestic product rose 0.4% in annualized terms in the April-June period, the slowest pace in three quarters and down from a revised 4.4% increase in the January-March quarter, the Cabinet Office said Monday.

The result was much worse than the median forecast for 2.3% growth in a poll of 16 economists by Dow Jones Newswires. GDP grew 0.1% compared with the previous quarter, when it rose a revised 1.1% on quarter.

Investors reacted by selling equities and buying safe-haven assets like bonds. Japan's Nikkei Stock Average closed down 0.6% at 9196.67, while the yield on the benchmark 10-year Japanese government bond fell 3.5 basis points during Asian trading to a seven-year low of 0.945%.

"The Japanese economy has already fallen into a lull," said Keisuke Tsumura, Cabinet Office parliamentary secretary for economic and fiscal policy. But Japan's economy minister Satoshi Arai sounded a more upbeat note, saying after the GDP results, "We don't need to move immediately based on the current situation."

While the economy is unlikely to fall back into recession, "how long and deep [it] will be in a lull is worrying," said Masatoshi Sato, a senior strategist at Mizuho Investors Securities.

The lull may heighten anxiety in Japan that it is ceding ground to China, which could displace Japan to become the world's second biggest economy after the U.S. this year.

Japan's nominal GDP dropped 0.9% on quarter, or an annualized 3.7%, to 118.538 trillion yen, or $1.288 trillion. That was below China's nominal GDP of $1.337 trillion in the quarter. The Cabinet Office said it used average exchange rates for the quarter of 92.01 yen and 6.823 Chinese yuan to the dollar for the dollar-based figures.

China's nominal quarterly GDP has twice previously been greater than Japan's in dollar terms—in the fourth quarters of 2008 and 2009—although its nominal GDP in 2009 was still below Japan's at $4.98 trillion compared with the island nation's $5.07 trillion. Still, economists say current growth trends suggest China could surpass Japan in 2010.

"With the government currently focused on fiscal reconstruction, the chances of additional fiscal spending are declining sharply," said Goldman Sachs economist Chiwoong Lee. While government purchase incentives for electronic goods, cars and other products has buoyed spending, the government is unlikely to extend or expand those programs as they expire in the months ahead, Mr. Lee said.

Private consumer spending, which accounts for nearly 60% of Japan's GDP, was flat in the April-June period, compared with a revised 0.5% growth in the previous quarter.

A recovery in wages, as summer bonuses rose after sharp cuts last year, kept spending from slowing further. But the low levels persisted in part as a weak jobs market weighed on consumer sentiment. In June, the unemployment rate hit a seven-month high at 5.3%.

Deflation also continued to drag on economic growth. Persistent price falls encourage consumers to defer purchases as they wait for prices to fall even further. They also hurt business investment by weighing on firms' bottom lines and increasing real borrowing costs.

The GDP deflator, the broadest measure of price trends, was minus 1.8% during the April-June quarter. The result represents a mild improvement from the minus 2.8% in the previous quarter, as price falls have eased slightly. But it still underscores how deeply entrenched deflation is in Japan.

"The risks of protracted deflation are increasing rather than improving," in contrast with the Bank of Japan's outlook, said Junko Nishioka, chief economist at RBS Securities Japan. That could prompt the government to put more pressure on the Bank of Japan to take additional easing measures, analysts said. The central bank's policy board, which held a regular two-day meeting last week, decided against taking such steps for now.

Amid speculation that Prime Minister Naoto Kan may call for an emergency meeting with Bank of Japan Gov. Masaaki Shirakawa in the coming days, analysts said such political pressure would likely be necessary to force the central bank's hand.

"The BOJ is unlikely to react to softer GDP numbers and the bank will maintain its present monetary policy stance until any political decision is made to stop deflation and change the direction of the yen," said Credit Agricole chief Japan economist Susumu Kato.

Corporate capital investment rose by 0.5% in the April-June period, following a 0.6% rise in the previous quarter. While the result marked the third straight quarter of gains, economists say recent weakness in leading indicators of spending suggest business spending, which accounts for 16% of GDP, may moderate for the rest of the year.

Domestic demand subtracted 0.2 percentage point from GDP growth, compared with the 0.5 percentage point it added in the previous quarter. Despite the negative result, some analysts said they expect business spending and consumption to improve in the coming months. As domestic demand will likely return to positive territory, the "Japanese economy will likely continue growing" in the July-September period, said Nikko Cordial Securities chief market economist Mari Iwashita.

The contribution to GDP from external demand, or exports minus imports, was at 0.3 point in April-June from a revised 0.6 in the previous quarter.

The slowing of Japan's growth could add to concerns over the global economy. The world's other economic power-houses have recently seen momentum fade. The U.S. economy grew at an annualized 2.4% in April-June, down from 3.7% in the previous quarter. China's growth, though still strong, slipped to a 10.3% on-year expansion in April-June from 11.9% in the previous quarter. While data Friday showed GDP in the European Union expanded 1.7% on year in the second quarter from 0.6% in the previous quarter, economists say the current pace of growth is unlikely to last.

Further clouding the outlook for Japanese exports is the recent strengthening of the yen. The dollar fell last week to 84.72 yen, its lowest since July 1995. A strong yen makes Japanese products less competitive overseas and eats into revenue sent back to Japan.

Mr. Arai, the economy minister, said that the government and the Bank of Japan must keep working together to curb the yen's recent strength.

But Mr. Arai indicated the government may not yet view the currency's strength as a big enough threat to warrant currency market intervention. Policy makers need to spend a bit more time analyzing whether the strong currency "could become a major obstacle" to the nation's economic recovery, he said.

Source: online.wsj.com