Japan’s business sentiment has taken a hit, with the latest central bank survey revealing a decline in the service sector’s mood due to rising costs driven by a weaker yen. This comes alongside a rare unscheduled downgrade of Japan’s GDP data, showing the economy shrank more than initially reported in the first quarter of 2024. These developments complicate the Bank of Japan’s (BOJ) decision on the timing of its next interest rate hike, as it navigates a challenging economic landscape.
The latest Tankan survey by the Bank of Japan highlights a decline in business sentiment within the service sector. Rising costs, exacerbated by a weaker yen, have put pressure on service-sector firms, leading to a drop in confidence. The sentiment index for big non-manufacturers fell to +33 in June from +34 in March, marking the first decline in two years. This decline reflects the challenges faced by service-sector companies as they grapple with higher labor and raw material costs.
Despite the decline in the service sector, the sentiment among big manufacturers showed a slight improvement. The index for big manufacturers rose to +13 in June, up from +11 in March, driven by a rebound in auto output and the ability to pass on rising raw material costs through price hikes. However, this improvement in manufacturing sentiment was not enough to offset the overall decline in business mood, highlighting the mixed economic outlook.
The survey also revealed that long-term corporate inflation expectations have risen slightly, with companies projecting inflation to hit 2.3% three years from now and 2.2% five years ahead. This increase in inflation expectations adds another layer of complexity to the BOJ’s decision-making process, as it balances the need to support economic growth with the goal of achieving its inflation target.
Impact of GDP Downgrade
In addition to the decline in business sentiment, Japan’s GDP data has been downgraded, further clouding the economic outlook. A revision to historical data showed that Japan’s real GDP shrank by an annualized 2.9% in the first quarter of 2024, down from an earlier estimate of a 1.8% contraction. This downgrade reflects corrections made in past construction orders data and indicates that the economy contracted more sharply than previously thought.
The GDP downgrade is likely to force the BOJ to cut its growth forecasts in its upcoming policy meeting at the end of July. The revised data also showed that GDP for the third and fourth quarters of last year were lower than initially reported, adding to the concerns about the strength of Japan’s economic recovery. This unexpected revision complicates the BOJ’s efforts to gauge the appropriate timing for its next interest rate hike.
The downgrade in GDP data underscores the challenges faced by the Japanese economy as it navigates a period of uncertainty. The weaker-than-expected economic performance raises questions about the sustainability of the recovery and the effectiveness of current monetary policies. The BOJ will need to carefully consider these factors as it formulates its policy response in the coming months.
BOJ’s Policy Dilemma
The combination of a shaky business mood and a GDP downgrade presents a significant dilemma for the Bank of Japan. The central bank is under pressure to support economic growth while also managing inflation expectations and ensuring financial stability. The latest data complicates the BOJ’s decision on the timing of its next interest rate hike, as it weighs the risks and benefits of tightening monetary policy in the current environment.
Analysts suggest that the improvement in business sentiment may have peaked, particularly for non-manufacturers, making it difficult for the BOJ to justify an early rate hike. However, the slight increase in corporate inflation expectations keeps alive market expectations for a near-term rate hike. The BOJ will need to strike a delicate balance between supporting the economy and managing inflationary pressures.
The upcoming policy meeting at the end of July will be closely watched for any signals on the BOJ’s future policy direction. The central bank’s decisions will have significant implications for the Japanese economy and financial markets. As the BOJ navigates this challenging landscape, it will need to remain flexible and responsive to evolving economic conditions.
In conclusion, Japan’s shaky business mood and GDP downgrade have created a complex environment for the Bank of Japan as it considers the timing of its next interest rate hike. The decline in service-sector sentiment, coupled with the unexpected GDP revision, highlights the challenges faced by the Japanese economy. The BOJ will need to carefully assess these factors as it formulates its policy response in the coming months.
