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All eyes on BoJ as Japan’s economy registers strong growth

The better-than-expected financial results will likely fuel speculation that the Bank of Japan may initiate policy normalization after a decade of aggressive monetary easing

Japan’s economy exceeded expectations by expanding faster, driven by the relaxation of the COVID restrictions, which boosted consumer spending. This positive outcome has sparked speculation regarding the possibility of an early national election and a potential shift in central bank policies.

According to the latest Cabinet Office data, the country’s GDP grew at an annualized rate of 1.6% during the first quarter of 2023, marking the most robust growth in the last three quarters of the financial year of 2022-23.

This expansion has surpassed analysts’ predictions of 0.8% growth and came after a technical recession at the end of 2022, which was revised in recent figures.

The primary drivers of this growth were better-than-expected spending by consumers and businesses, although trade harmed the overall figures.

Atsushi Takeda, the chief economist at Itochu Research Institute, highlighted the importance of investment for companies in light of the returning domestic demand and labour shortage, suggesting that corporate capital investment plans will likely stay the same in the short term.

This stronger-than-anticipated economic performance is favourable for Japan’s overall recovery and may give Prime Minister Fumio Kishida more flexibility in considering an early election. As Fumio Kishida hosted the Group of Seven (G7) leaders in Hiroshima in June 2023, a successful summit could further boost his support ratings.

The fact that Japan’s economy is growing faster than expected amid a global downturn could also reassure the Bank of Japan as newly appointed Governor Kazuo Ueda evaluates the sustainability of economic growth, wages, and prices. Some market players and economists anticipate policy adjustments by Ueda before the completion of a review initiated in April 2023.

The better-than-expected financial results will likely fuel speculation that the Bank of Japan may initiate policy normalization after a decade of aggressive monetary easing. However, despite persistent speculation, Governor Ueda has repeatedly stated that the bank has yet to project inflation above its 2% target, indicating that it will need to maintain its easing measures.

Meanwhile, the Bank of Japan (BOJ) board member Asahi Noguchi has now said that the central bank must maintain an ultra-loose monetary policy to ensure wages, seen as key to driving inflation to its 2% target.

As the third largest economy globally, Japan’s economy faces a mix of favourable and unfavourable factors as it strives to gain momentum toward a robust post-pandemic recovery. The government recently downgraded its classification of COVID-19 to be on par with seasonal flu, which, combined with stronger wage growth and additional government relief measures, supports domestic consumption. Nevertheless, the ability of paychecks to keep pace with the sticky inflation remains to be determined.

Downside risks for the Japanese economy primarily stem from concerns about a global economic slowdown triggered by higher interest rates to mitigate inflation. Weaker overseas demand will likely impact Japan’s exports negatively and discourage companies from making capital investments. The latest data reveals that net trade had a more significant drag on last quarter’s growth than estimated.

Japan’s economy has experienced alternating periods of growth and contraction during its post-pandemic recovery, lagging behind its global counterparts. Since 2021 beginning, Japan’s economy has contracted in five out of nine quarters.

While inflation in Japan has remained above the Bank of Japan’s 2% target for some time, Governor Ueda expects it to fall below that level later in 2023-24 as the cost-push factors related to energy and commodities gradually fade away.

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