Abe: Third time lucky?

As expected, last weekend’s general election saw Shinzo Abe triumph for the second time in two years to take office as PM for the third time. His LDP again won more than 60% of seats in the Lower House to retain complete control of its committees. And with coalition partner Komeito increasing its share, the ruling parties retained their two-thirds super-majority providing scope to overturn any opposition in the Upper House. The landslide victory also strengthens Abe’s own position within the LDP, reducing the likelihood of a near-term challenge to his leadership. And so, he now stands in good stead to become the longest serving Japanese leader since Eisaku Sato’s near-eight-year tenure more than four decades ago.

In terms of economic policy, what does this mean? A chance to give Abenomics the time it needs to shift Japan on a lasting basis out of deflation. Much of the impetus will, of course, continue to come from Abe’s ‘first arrow’, as the BoJ implements its massive expansion of QQE. But learning the lesson from April’s consumption tax hike – which now looks a blatant policy error running counter to the main reflationary thrust of Abenomics – the second arrow should provide a little more support too. A modest supplementary spending package (circa ¥3trn) is likely to be forthcoming early in the New Year, while an outline for tax revisions for FY15, including an initial reduction in the corporation tax rate and postponement of the next consumption tax hike, should be published by year-end. And, while the LDP’s election manifesto was predictably light on detail, before too long there might even be more substantive progress on the growth-friendly aspects of Abe’s ‘third arrow’ structural reform agenda, such as further enhancing corporate governance, accelerating deregulation, and pushing ahead with nuclear plant restarts.

The need for fresh policy impetus to renew momentum in the economic recovery has been made clear by countless recent data and surveys. While certainly not overwhelmingly downbeat, the past week’s BoJ Tankan survey was consistent with that trend. For example, while large manufacturers suggested that conditions broadly stabilised in the final quarter of 2014, they were less upbeat about the near term, forecasting a deterioration to the least favourable since the first half of 2013. And while large non-manufacturers were more optimistic about the current economic environment, they also anticipated no improvement in conditions over the coming three months.

Partly due to their concerns about the impact of the weak yen on import prices, small firms are finding conditions most challenging. In particular, according to the Tankan, small manufacturers foresee a notable worsening in conditions ahead at the steepest pace since the Great East quake. And overall, while the survey still signalled firms’ intention to increase investment over the near term, it also suggested that they have lost a degree of confidence in the outlook, hardly indicative of robust GDP growth over the near term.

Meanwhile, with respect to inflation, firms continue to expect consumer price inflation to fall short of the BoJ’s 2% target as far out as 2019. More importantly perhaps, they also expect to see little increase in the prices charged for their own goods and services, with the Tankan suggesting that large manufacturers anticipate a cumulative decline in the prices of their goods over the coming five years – hardly a judgement likely to lead to large-scale increases in wages.

And no doubt about it, despite the weaker yen, the recent plunge in oil prices will place significant downward pressure on inflation over coming months. Having recently slipped back below 1%Y/Y, we expect underlying core CPI to fall to just 0.2%Y/Y by the middle of 2015. With risks to that forecast probably skewed to the downside, a return to deflation in the coming year can hardly be ruled out. So, Abe and the BoJ look set to have their work cut out if they are going to banish once and for all the ‘deflationary mind-set’ that plagued Japan for the past two decades, let alone eventually achieve the 2% inflation target.

But it is by no means all doom and gloom. The Tankan survey again signalled firms’ intention to increase investment over the near term. It also suggested that in several sectors capacity constraints continue to bind, which – if and when base effects from the current shift in the oil price have worn off in a year’s time – suggests that inflation might gradually recover once again. With firms asserting that labour shortages are the most acute since the early 1990s, there should be scope for continued gradual increases in employment and wages in coming months. And today’s trade report showed that exports trended to their highest level since 2011, suggesting that net trade will boost GDP growth for the third consecutive quarter in Q4.

If Abe plays his cards wisely, acting swiftly to restore confidence and re-establish the positive momentum that April’s premature consumption tax hike snuffed out, firmer economic growth (both actual and potential) and a sustained inflationary push would be back within grasp. That – rather than a further premature tax hike – would also offer the greatest hope of re-establishing fiscal sustainability. So, don’t give up on Abenomics just yet – Abe’s third stint in the Kantei might just turn out to be third time lucky.

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