Japanese GDP drops to lowest level since 2011

Emily Nicol
Chris Scicluna

Key points:

  • Japanese GDP drops at a record rate as consumer spending and exports plunge.
  • Flash PMIs, as well as US housing, and UK and Japanese inflation, the data highlights this week.
  • Minutes from recent Fed, ECB and RBA policy meetings also due.

Against the backdrop of the national State of Emergency in April and May and more severe restrictions in Europe and the US, today’s initial estimate of Japan's Q2 GDP inevitably recorded a significant contraction, with overall output down 7.8%Q/Q (27.8%Q/Q annualised) – a better performance than other G7 economies in Q2, but nevertheless worse than many of its regional counterparts. This marked the third consecutive quarterly drop in Japan’s activity, was more than 1½ times the steepest pace of decline during the global financial crisis, and left output down more than 10% compared with the pre-consumption tax hike level in Q319. Indeed, the level of GDP was at its lowest since the 2011 quake.

Within the detail, the weakness was widespread. Private consumption took a further massive hit (-8.2%Q/Q, to subtract 4.6ppts from quarterly GDP growth) as the closure of retailers and recreation activities left spending at its lowest level since 2001. While spending on goods was inevitably impacted – consumption of durable goods was down 3.9%Q/Q, and non-durable goods down 3.3%Q/Q – spending on services also plunged 12.7%Q/Q, to the lowest level since 1997.

Given the steep drops in GDP recorded in the US and Europe, trade was also inevitably a major source of weakness. Exports plummeted by 18½%Q/Q, with goods and services down at similar rates, with the later impacted by the absence of overseas visitors as travel bans remained in place during the quarter – indeed, spending by tourists fell a further 81.2%Q/Q following a drop of almost 45%Q/Q in Q1. So, with imports down just 0.5%Q/Q, net trade subtracted a record-3ppts from quarterly growth.

Perhaps surprisingly, and most encouragingly, private sector capex held up relatively well, with the 1½%Q/Q decline merely offsetting the increase in Q1. Supported by recent fiscal stimulus packages, public sector investment also rose for the fifth month out of the past six, albeit making little contribution to growth. But government consumption unexpectedly fell 0.3%Q/Q.

While last week’s JCER monthly estimate of GDP suggested that the economy grew by 2.7%M/M in June, this also implied that less than one quarter of the drop between February and April had been recovered, leaving it still more than 8% below February’s pre-pandemic peak. And today’s revised industrial production figures for June showed a more modest rebound in output that month than previously thought (+1.9%M/M, compared with the initial estimated increase of 2.7%M/M), to leave it still one fifth below the pre-Covid peak.

Looking ahead, while continued gradual recovery in demand from overseas should provide greater support over coming months, and fiscal policy will also provide a boost, the near-term recovery in domestic demand might well be hindered by the recent rise in coronavirus cases. Certainly, risks remain firmly skewed to the downside and there is bound to be a significant shortfall in GDP from the pre-pandemic level for several quarters to come.

The remainder of the week’s Japanese data flow will provide greater insight into economic conditions in Q3, with the Reuters Tankan survey and flash PMIs for August due tomorrow and Friday respectively, while July’s goods trade report and overseas visitor numbers are due on Wednesday. That day will also bring machine orders data for June, which will offer a guide to capex growth over coming months, while Friday’s release of July department store sales figures will provide an update on consumer spending at the start of Q3. Meanwhile, Friday will also bring the latest national CPI figures for July. While headline inflation is expected to have risen 0.2ppt to 0.3%Y/Y, the BoJ’s forecast measure of core inflation is forecast to have remained unchanged at zero.

Euro area:
The main euro area data focus this week will be the publication on Friday of the flash August PMIs for the euro area and its two largest member states. With economic activity having returned to greater normality as lockdown measures relaxed over recent months, and after the euro area’s composite index jumped to a near-two-year high of 54.9 in July, the surveys are expected to point to ongoing expansion in both the manufacturing and services sectors. However, high-frequency data have also suggested some levelling-off in the pace of expansion, which might be reflected in declines from the July PMIs. That day will also bring the European Commission’s preliminary consumer confidence index. While household sentiment has also reversed some of the initial post-Covid outbreak slump, further improvement seems likely to have been limited by renewed concerns about the rise in coronavirus infections across the region, as well as the uncertain labour market outlook.

Meanwhile, today will bring the Bank of France’s retail sales data for July. These will be followed by final euro area CPI figures for July on Wednesday. The preliminary estimate of euro area inflation unexpectedly rose 0.1ppt to 0.4%Y/Y, with core inflation up 0.4ppt to 1.2%Y/Y. But this primarily reflected a surge in clothing inflation in certain member states as containment measures delayed the start of the summer sales, an effect which seems bound to be reversed in August. Indeed, services inflation fell to its weakest since April 2016. Thursday will bring euro area construction output figures for June.

In terms of policy news, Thursday will see the publication of the ECB’s detailed account of its monetary policy meeting of 16 July. On that occasion, the Governing Council made no changes to policy, re-committing to keeping interest rates at the current levels or lower until the inflation outlook has moved back to target and reaffirming the PEPP purchase envelope at €1.35trn. In her subsequent press conference, President Lagarde stated that the ECB expects to purchase the full €1.35trn envelope unless there is a significant upside surprise to the economic outlook. But a subsequent report from Bloomberg suggested that there was not unanimity on the Governing Council on this point, and the account of the meeting might provide further colour on this aspect of the debate.

Like in the euro area, the back end of the week will bring the flash consumer confidence estimate and PMIs for August from the UK. Given the gloomy outlook for the labour market, with many more redundancies expected as the Job Retention Scheme is phased out, we expect consumers to be cautious about their spending plans for the coming months. And the PMIs might well suggest that firms plan to shed staff at an even faster pace than last month, particularly in the services sector. Nevertheless, the headline composite PMI is expected to point to continued expansion, after jumping to 57.0 in July, from 47.7 in June. Friday will also bring retail sales figures for July, which are expected to reveal another gain on the month, following an increase of 1.7%M/M in June, as spending patterns continued to improve somewhat.

Ahead of this, July’s CPI report, due on Wednesday, is expected to show that inflation remained close to June’s rate of 0.6%Y/Y, which represented an unexpected rise as retailers on the high street took advantage of returning shoppers. But while spending on goods likely continues to rise, we expect that the persistent shortfall of demand for certain services, the temporary 15ppt reduction in the VAT rate for the hospitality and entertainment sectors from 15 July to 12 January 2021, and the government’s Eat Out to Help Out restaurant meal subsidies this month, will likely push inflation close to or even beyond zero from August.

In the US, Wednesday’s release of the minutes from the FOMC’s most recent meeting will be closely assessed for clues regarding any future policy movements, while markets will be looking out for any progress on the fiscal coronavirus relief negotiations. Datawise, the first half of the week focuses on the housing market, with the NAHB housing market index for August due today, along with Q2 mortgage delinquencies data, and followed by housing starts numbers for July tomorrow. Thursday’s usual weekly jobless claims data will be accompanied by the release of the Philadelphia Fed business outlook survey for August, while Friday will bring the flash PMI surveys. Politics-wise, the Democratic National Convention will be conducted over the course of the week.

After a quiet start to the week for economic news from Australia, tomorrow will bring the ANZ Roy Morgan weekly consumer confidence indicator, as well as the minutes from the RBA’s monetary policy meeting at the start of the month, when Governor Lowe confirmed that the Reserve Bank had purchased government bonds for the first time in three months. The back end of the week will bring the flash August PMIs, as well as preliminary retail sales figures for July.

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