Japan’s Economy Enters Recession, Loses Position as World’s Third Largest to Germany
Japan’s economy has suffered an unexpected blow, plunging the country into recession and causing it to lose its position as the world’s third-largest economy to Germany. The decline in Japan’s gross domestic product (GDP) was primarily driven by weak domestic consumption, which fell below market forecasts.
In the last three months of 2023, Japan’s GDP shrank at an annualized pace of 0.4%, following a contraction of 3.3% in the previous quarter. This consecutive economic contraction meets the definition of a recession. Economists had anticipated a growth rate of 1.4% quarter-on-quarter for the October to December period.
The data confirms that Japan’s economy slipped to the fourth-largest in the world, trailing behind Germany in US dollar terms. The main factor contributing to this decline was the weakness in domestic demand. All major domestic demand categories, including consumer spending, experienced negative growth. The only positive contribution came from external demand, driven by exports of goods and services.
Private consumption, which accounts for half of Japan’s economy, declined by an annualized 0.9% in the fourth quarter. Japanese consumers faced higher prices for food, fuel, and other goods, leading to a third consecutive quarter of falls in private consumption. The weak yen played a significant role in contributing to the higher cost of living, as Japan imports 94% of its base energy requirements and 63% of its food.
Neil Newman, a Tokyo-based strategist at Japanmacro, explained that private consumption was particularly weak and would worsen following the recent Sea of Japan earthquake. Natural disasters often lead people to stop spending, exacerbating the economic challenges faced by the country. The earthquake on January 1 shook the Noto Peninsula in Ishikawa prefecture, resulting in collapsed buildings, fires, and tsunami alerts.
Capital expenditures also dropped for a third consecutive quarter during the fourth quarter, with a decline of 0.3%. Additionally, investment in housing by the private sector tumbled by 4%. However, external demand provided some support to overall growth, as exports jumped by an annualized 11% from the previous quarter, aided by the weak yen. Inbound consumption, including spending by tourists, also rose sharply.
Despite entering a technical recession, Japan’s markets have remained resilient. The benchmark Nikkei 225 index advanced 1.2% and closed above the 38,000 level for the first time since 1990. This suggests that investors remain confident in Japan’s long-term prospects.
There is hope for a recovery in the coming months, according to some economists. Min Joo Kang, a senior economist at ING Group, expects GDP to rebound in the first quarter of 2024. Factors such as a stabilization in inflation, expected growth in wages, strong corporate earnings, and solid demand for IT are likely to contribute to an improvement in private consumption and facility investment.
Analysts at Capital Economics also believe that business surveys and the labor market present a more positive outlook than the headline numbers suggest. The unemployment rate dropped to an eleven-month low of 2.4% in December, and the Bank of Japan’s Tankan survey indicated strong business conditions across all industries and firm sizes.
Goldman Sachs predicts 1% growth for Japan’s economy in the first quarter of 2024. They expect a slowdown in inbound consumption compared to the rapid rise in the previous quarter but still anticipate a moderate uptrend. Capital expenditure could also rebound by 1.3% during the same period.
Looking ahead, analysts from Capital Economics anticipate an upward revision of the fourth-quarter GDP figures in March. They believe these figures are unlikely to prevent the Bank of Japan from ending its negative interest rates in April.
Despite the economic challenges, Japan’s equities market had a remarkable year in 2023. The Nikkei index surged by 28%, making it the best-performing market in Asia. Morgan Stanley reiterated its bullish view on Japan’s equities, stating that it is their largest recommendation in their coverage universe. The rally in Japan’s equities can be attributed to ongoing corporate reforms, improving return on equities, and the boost in profits for Japanese exporters due to the weak yen.
In conclusion, Japan’s unexpected recession and loss of its position as the world’s third-largest economy to Germany have raised concerns. Weak domestic consumption, driven by higher prices and natural disasters, has been the primary cause of the economic decline. However, there are signs of hope for a recovery in the coming months, with expectations of improved private consumption and facility investment. Despite the economic challenges, Japan’s equities market has remained strong, driven by corporate reforms and the weak yen.