Japan recession: Rising inflation, weak yen spur government stimulus to stem unprecedented risks to economy
Japan continues to push the limits of its economic recovery as the country finally eases out of the Covid-19 pandemic, but headwinds abound.
With inflation at an eight-year high and the promise of further stimulus to come, analysts are fearful that the central bank may be forced to turn hawkish and inspire the next Japan recession.
What is a recession?
Recessions are technically defined as two consecutive periods of negative economic growth, with those periods typically quarterly.
In the US, for example, the Business Cycle Dating Committee at the National Board of Economic Research (NBER) officially announces a recession, taking a more measured approach, observing economic indicators like unemployment, income and consumption in addition to a decline in output.
While the former is a seemingly innocuous barometer, recessions indicate a broader issue with the economy, suggesting either an exogenous shock or a downturn in the natural business cycle. It signals falling incomes and profits for businesses, which can in turn cause wages to fall for workers or increase unemployment, hurting consumption and forcing a further reduction in incomes.
Policy responses tend to try and stimulate the economy out of a recession, with central banks cutting interest rates and pumping more liquidity into the financial system through quantitative easing, though this depends on the state of inflation.
Governments may also try to respond with expansionary fiscal policy by cutting taxes to stimulate incomes, but this is much more of a political decision than those taken by central banks.
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Japan’s recession history
Japan’s recessions tend to run against Western business cycles, with two notable downturns coming while the West was experiencing strong growth. The last Japan recession occurred in 2018 and lasted 18 months, according to an analysis by a Cabinet Office panel of economists.
The economists determined the country’s latest contraction began in November 2018 when its exports bore the brunt of an escalating US-China trade war and was bookended by a Japan economic crisis with a steep 30% contraction when the Covid-19 pandemic struck in the second quarter of 2020, leading to widespread lockdowns.
The country experienced a huge and prolonged contraction through the 1990s, in what was known as the Lost Decade, which became an example of an L-shaped recession where a drop in output wasn’t met with a rebound, representing a major period of Japan economy stagnation.
Is Japan in a recession right now?
There currently aren't any major signs of a Japan economic recession. The country flirted with the prospect of recession at the beginning of the year when it posted a modest 0.1% increase in gross domestic product (GDP) in Q1 2022, signalling a slowdown. But it recovered with 0.9% GDP growth in Q2, driven by easing covid restrictions which spurred capital expenditure.
The country’s economy just returned to pre-Covid levels of output in August 2022, but is still 2.3% below peak levels seen in the second quarter of 2018.
Analysts think Japan is primed to enjoy a fruitful end to 2022, with positive signals outweighing some wider global headwinds for now.
In a July research note, Deloitte economist Michael Wolf indicated Japan’s economy was fighting between pent-up demand and wider countercyclical pressures that may halt a recovery. He said:
“Japan’s economic recovery is likely strengthening as pent-up demand pushes consumer spending higher. However, inflation is outstripping wage gains, raising the risk that the rise in consumer spending may be short lived.
“The trade balance is also likely to improve as tourism returns and China comes out of lockdowns. Unfortunately, a weakening global economy likely presents a serious risk to external demand.”
In a September research note, which included an upgrade to future GDP growth expectations, ING senior economist Min Joo Kang wrote that the country was likely to see expansion driven by a continued easing of Covid-19 restrictions. The analyst wrote:
“The latest data releases from Japan point to a solid recovery in the near future and are a positive sign for the wage growth that the Bank of Japan is seeking.
“Japan is reopening its economy at a slower pace than other Asian countries and the reopening effects are just kicking in, which should be the main driver for the positive outlook for the second half of the year.
“However, as the headwinds of the global recession grow, the BoJ will take its time to determine whether Japan can still deliver solid outcomes in a sustainable way.”
What factors are causing recession in Japan?
Relative to much of the Western world, Japan has so far largely been able to buck a trend of rising prices linked to the lifting of Covid-19 restrictions and Russia’s invasion of Ukraine, but there are signs that the country's long relationship with stagnant prices could be coming to an end.
The country’s consumer prices index (CPI) rose by 2.8% last month, which, while a far cry from near-double-digit jumps seen in the US, still marks the fastest rise in prices in the country since 2014.
Despite that, the Bank of Japan (BoJ) has held off on raising rates and tried to temper demand. The BoJ maintained its base rate at -0.1% at its sixth monetary policy meeting of the year on 22 September.
More pressures could loom on the country’s balance sheet, with Bloomberg reporting that Japanese Prime Minister Fumio Kishida had ordered his government to come up with an economic stimulus package by the end of October in a move that economists warned could lead to overspending further pushing inflation.
ING didn’t expect the bank to turn any more hawkish at its remaining four meetings, suggesting it would take a while for rates to begin moving upwards. That should lessen the chances of a Japan recession, though the latest jump in prices will continue to test the bank’s resolve.
One consequence of the bank’s dovishness has been Japan’s currency quickly losing its value, raising the price of imports. The Japanese yen is down 20% against the dollar (JPY/USD) this year, with the dollar becoming an increasingly attractive safe haven asset. The Bank of Japan’s reluctance to increase rates has caused investors to further flee the currency. Continued delays from the bank may finally force Japan’s price rises into uncomfortable territory.
JPY/USD exchange rate
But, as ING’s Min Joo Kang pointed out, this may be offset by rising demand for tourism in a country that had to largely do without it for around two years.
The country’s labour market also shows limited signs that a Japan recession is imminent, as slack from Covid-19 restrictions continues to drive employment. A Euronews report found that Japan continues to show elevated demand for workers, which is expected to increase as more tourists flood back into the country.
Japan economy forecasts for 2022 and beyond
Alongside general optimism from analysts about the direction of travel, Japan economy forecasts cast a positive light on the country’s GDP growth, with little expectation of a recession.
In June, the Organisation for Economic Co-operation and Development (OECD) predicted Japan to register GDP growth of 1.7% in 2022 and 1.8% in 2023.
In its latest forecast from September, the Mitsubishi UFJ Financial Group didn’t expect a Japan recession in the coming years, forecasting GDP growth of 1.8%, 2.1% and 1.2% between 2022 and 2024, first driven by private consumption, then by private capital investment. The group wrote:
“We would expect personal consumption to be a core factor helping to put the economy back on the recovery track. Depending on the status of infections, measures to stimulate tourism demand could also help get the economy moving.
“Government policy such as, including last year's supplementary budget, anti-inflation measures, and allowing foreign tourists into the country could also underpin the economy.”
In the nearer term, Goldman Sachs’ chief Japan economist Naohiko Baba was subdued with his Japan economy forecast.
“We forecast real GDP in Q3 will remain on a moderate growth path led by domestic demand as the government is not implementing any particular measures to restrict economic activity despite a resurgence in COVID-19 infections.
“That said, we note that rising inflation driven by cost-push factors, such as higher commodity prices and the weak yen, could depress consumer sentiment, while the risk of a recession has risen in Europe and the US in particular.”
A Japan recession in 2022 looks unlikely, with the country continuing its rally out of the pandemic. But policymakers are pushing inflationary buttons in a world where prices are elevated and confidence is low. A wrong move could steer the country into rockier terrain.
Note that analysts’ predictions can be wrong and should not be used as a substitute for your own research. Always conduct your own due diligence before trading, and never trade money that you cannot afford to lose.
FAQs
What happened to Japan's economy?
Japan’s economy is growing after an initial decline at the start of the year linked to Covid-19 restrictions. It is now experiencing eight-year high inflation as price pressures grow.
Is Japan's economy declining?
Japan’s economy grew at 0.9% in the second quarter of 2022, after 0.1% growth in the first quarter. It has avoided a recession so far.
Will Japan's economy recover?
Japan’s economy is recovering after Covid-19, recently surpassing pre-pandemic levels of output, but is still behind its peak from 2018.
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