Silent tapering

In a nutshell

• The steady uptrend in wages and rebound in activity data will ease concerns surrounding Japan’s negative 1st quarter GDP growth.
• Spring wage negotiations led to what should prove the best “base-pay” growth since 1998.
• The apparent dovishness of the Bank of Japan (BoJ) is contradicted by its quiet reduction in asset purchases and the debate regarding financial stability.

Recent economic reports confirm that the Japanese economy is bouncing back from its 1st quarter weakness. Industrial production and retail sales improved in April, while trade data suggests that exports will be a major contributor to GDP growth in the 2nd quarter, buoyed by the slightly weaker yen. Core machine orders (a rough proxy for corporate capital expenditure) also indicate that Japanese businesses’ appetite for investment remains decent.

Wage momentum finally seems to be firming, with the unemployment rate (at 2.5% in April) hovering above multi-decade lows. Although bonus volatility caused a dip in headline cash earnings growth, April saw the scheduled component of cash earnings maintain its fastest pace in two decades (+1.2%). In addition, spring wage negotiations appear to have settled the annual increment of entire pay schedules (unique to Japan’s age-based system) at 0.53%, probably the second-best outcome since 1998 (see chart VIII). Construction ahead of the 2020 Olympics should keep labour in tight demand, even if the government does go ahead with its second consumption tax hike in 2019.

Admittedly, headline and core inflation data have been more mixed. Aware of the risk that a “dip” may become more entrenched, the BoJ has signalled greater caution with respect to its inflation outlook, to be updated in July. We stress, however, that removal of BoJ guidance as to when its 2% inflation target could be reached should not be taken as a dovish sign. Had Japanese policymakers really been serious about achieving that target, they would have taken action in the meantime to raise inflation expectations and hasten the price recovery.

Also, recent BoJ policy meeting minutes suggest that some board members are actively voicing concerns about financial stability, a coded reference to persistently low rates and bond market illiquidity. The BoJ’s asset purchase history shows that banking sector complaints about these issues are having the intended impact: despite its supposed dovishness, the BoJ has been reducing its bond market presence markedly since 2016, occasionally tolerating an outright fall in its Japanese government bond (JGB) holdings (see chart IX). In effect, the BoJ has been using its 10-year yield target to mask a more neutral policy stance, helped in that by rising rates outside of Japan.