What Now in Japan?

The BOJ is holding at 0.5%, exports are booming, and capex stays afloat. So what will happen in Japan as we venture forward into 2007. Well, this is what I am trying to answer in a recent note over at GEM. Here is an exerpt from my summary.

So, on the economic outlook for Japan going forward I would especially like to stress one thing to watch, and that is the substantial risk of Japan falling back into deflation in March (and perhaps February) on a y-o-y basis. If this happens it will undoubtedly cause some ripples between the MoF and the BOJ where the latter will be accused of acting prematurely on the basis of a backward looking hike in February. The other thing is industrial production which almost inevitably fell in February on a m-o-m basis due to de-stocking on the back of the unsustainably high capex seen in Q4 2006. The evolution of the export surplus from March onwards will determine just how much capex can be ramped up in the months to come, and this again depends on how key economic data coming out of the US (and to some extent also China) evolves. On consumer spending, we should expect to see a small pick-up over the next few months on a m-o-m basis but I am not bullish about the evolution of consumer spending on a y-o-y basis.

Interestingly I might have to revisit my view on Japan slipping into deflation on a y-o-y basis on the back of a dropping headline inflation rate. As such, the headline is ticking slowly back up at the moment and since Japan includes energy in their core inflation figures this is (at least for Japan) some sort of good news. Whether it is too late is of course another story and I maintain my view that Japan will be slipping into deflation in February and March on a y-o-y basis and in the end we really need to exclude energy from Japan's price index in order to get the right picture. Also, I think that it is not necessarily a great disaster if Japan slips into deflation in February and March (I mean the headline will probably be pushing up again in the rest of 2007 unless of course the US totally crashes) but more so the internal power struggle between the MoF and the BOJ will be exacerbated and I am sure that the MoF is poised to strike at the BOJ for raising prematurely should Japan touch base with deflation.