​Japan's Two-Speed Economy Holds Back Policymakers

Japanese Finance Minister Shunichi Suzuki said on Tuesday he was concerned about the negative implications of the current weakness in the yen and its effect on incentives to increase wages.

"One of our major goals is to achieve wage increases that exceed the rise in prices," he said. "On the other hand, if prices continue to remain high, it will be difficult to reach this target even if wages rise."

Yen bears have hit a home run this year, sending the currency to a new 34-year low of 160 in late April. As we predicted in our report for Q3 2023, the yen is losing its safe haven status.

The sharp depreciation has become a headache for Japanese policymakers as it hurts consumption and push up import cost. Recent upsurge in commodity prices adds fuel to the fire.

About 64% of firms surveyed said the yen weakness eroded their profits as they were unable to pass on rising costs to customers via price increases, according to a report published by Teikoku Databank.

About half of surveyed companies said a yen trading around 110-120 to the dollar would be appropriate – unattainable at least in the short run. The report included both exporters and importers.

The currency is a "big problem," Japan Airlines Co. Chief Executive Officer Mitsuko Tottori said earlier this month, adding that she would like to see it retrace back to around 130 per dollar.

Last ditch

Selling pressures re-emerged following suspected interventions during this month. The yen is languishing around 156, so the BOJ looks like an integral part of the forthcoming effort to prop up the yen.

The central bank may raise interest rate as many as three more times this year, with the next move potentially coming as early as June, according to a former BOJ chief economist Toshitaka Sekine.

"My sense is that there is no problem at all even if they raise rates three more times this year, provided conditions are sufficiently favourable," he said, adding "there is nothing pre-determined."

Vanguard Group and PIMCO share his views that are more hawkish than those of most BOJ watchers, although an increasing number of analysts have flagged the risk of a July hike.

The BOJ's summary from its April policy gathering indicated more hawkish tilt among the board, with one member saying the rate path may be higher than what the market currently expects.

The BOJ is probably thinking a higher rate will be necessary if the yen disrupts the price trend, given that businesses have started to adapt their price-setting behaviour to inflation, Toshitaka said.

Key is whether a virtuous wage-price cycle can be clearly seen by the autumn when economic indicators for July and August reflecting the impact of Shunto are available, according to Western Asset Management.

Pinch of slowdown

Japan's economy fell faster than expected in Q1 as weak consumption bit, throwing a fresh challenge to the central bank's push to take interest rates further away from zero.

Downwardly revised data showed GDP barely grew in Q4 2023 and the across-the-board declines in all GDP components suggest Japan's economy had no major growth engine in the last quarter.

"It would be possible that the timing of rate hikes could be pushed back depending on how the GDP may rebound in the current quarter," said Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities.

Economists are hopeful the recession will prove temporary and expect the drag to growth from an earthquake in the Noto area and the suspension of operations at Toyota's Daihatsu unit to dissipate.

Japan’s imports rebounded in April, pushing the nation’s trade balance into deficit. The negative factor for GDP reflects the growing pain associated with a falling local currency.

Exports to the US rose 8.8%. Strong demand in overseas markets signals that the economy could return to growth in Q2 while underscoring positive outlook on the US growth.

Japan's core consumer inflation probably slowed for a second straight month to 2.2% from 2.6% in March in April from a year earlier, a Reuters poll showed, leaving policymakers in a worse predicament.

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