Japan - Once the pandemic is over, Japan may leverage on some tailwinds

Key points

  • Japan hasn’t been as badly exposed to COVID-19 as other countries and significant support from the government and the Bank of Japan make it more resilient. Some restrictions may return in the coming weeks, but it should be less strict than in April
  • Private consumption is crucial for the outlook, a high saving rate, job market resilience and large demand stimulus should underpin this outlook
  • After a -5.5% contraction in 2020, we believe GDP should rebound by +3% in 2021 and +2% in 2021

Pandemic management remains crucial

The short-term outlook remains constrained by the evolution of the pandemic. Japan has been resilient so far and currently only 15% of intensive care unit is occupied nationwide. The number of new cases is rising but we believe Japan will be able to cope with a resurgence of the pandemic without having to impose strict restrictions. Large and coordinated support from the government and the Bank of Japan (BoJ) has been, and will remain, crucial[1]. For the time being, retail sales are getting back to pre-crisis levels, but the service sector is still suffering, while industrial production has recovered only half of its loss. In addition, following the strong recovery in China and bigger auto demand in the US, exports currently stand at -5% of 2019’s level.

Private consumption is likely to drive Japan’s recovery. Last year’s sales tax hike and the pandemic have distorted consumer behaviour, but some tailwinds may facilitate the rebound. Income has been largely preserved thanks to various fiscal support from the Employment Adjustment Subsidy Programme as well as cash handouts to households and SMEs[2]. Consequently, both precautionary and forced savings have risen, pushing the saving rate to an unprecedented 25% of disposable income. The job market has also been resilient with unemployment rising by only 0.6 percentage points (ppt) to 3%, while job offers per applicant remains at one. Finally, a third supplementary budget of ¥7tn is likely to stimulate demand in Q1 2021. The “Go to” campaign, offering discounts on domestic travel should be extended through 2021 and cash handouts should be granted to low income households.

In terms of investment, the outlook is more mixed. On one side, the capital stock has not been destroyed and production – related investments should be muted until demand accelerates substantially. On the other, Japan is likely to accelerate into digitalisation with a ¥15tn plan included in the 1st supplementary budget, while 2021 budget should contain tax incentives. In addition, PM Suga would like to endow Japan with a plan to reach carbon neutrality by 2050. It is too soon for concrete figures, but the country may see large stimulus in sectors such as energy, transport and housing. On trade, we also expect a gradual recovery over the coming quarters with the global economy likely shifting into an expansionary phase. The greatest risk could be another virus-related supply-chain disruption in the US.

Overall, we expect GDP will rebound by 3% in 2021 and 2% in 2022 (Exhibit 1). Despite positive headlines, GDP isn’t expected to return to its pre-crisis level before Q2 2022. Assuming Japan’s potential growth continues at around 0.5%, this would be 0.6ppt below potential at that time.

Exhibit 1: GDP growth and contributions

Source: Cabinet Office and AXA IM Research, as of 18/11/2020

Falling inflation could increase BoJ discomfort

In the short term, CPI inflation should weaken further, depressed by a sharp decrease in the output gap and the impact of some measures such as the “Go to” campaign, and a likely lowering of mobile phone charges. Consequently, CPI should decline to -0.2% in 2021 and only rise to 0.1% in 2022.

In this context, the BoJ will face additional calls for more accommodative policy. There is still leeway on its special programme to support corporate financing and we believe that this should be extended until Q3 2021, as long as the demand exists. In parallel, the BoJ will continue to flexibly adjust its JGB purchases, facilitating the additional issuance by the government. The BoJ will be keen to avoid taking rates deeper into negative territory, considering the possibility of further stress on the financial system. Finally, if the yen appreciates beyond the implicit ¥100/USD threshold, the BoJ may face a difficult decision.

[1] Le Damany, H., “Japan’s COVID-19 response: Crisis met with strong economic package, but is it enough?” – June 2020

[2] Le Damany, H., “COVID-19, economic stimulus and monetary policy... How is Japan responding to the crisis?“ – May 2020

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