Hopes rise as Japan’s economy grows 6% in 3Q11

The economy grew a strong 6.0% QoQ saar in 3Q, better than the consensus forecast of 5.8% and our initial estimate of 5%. The growth recovery was broad based. Exports rose strongly to exceed the pre-earthquake levels (+27.4% in 3Q), thanks to the supply restoration in the manufacturing sector.

Investment picked up moderately (+3.4%), mainly driven by the private sector investment, particularly private residential investment as a result of reconstruction.

Private consumption also made a solid recovery in 3Q (+3.9%), supported by the pent-up consumer demand. Looking from a longer-term perspective, however, there remains a small negative gap between the current level of private consumption and its peak level in prior to the 2008 GFC (-1.5%). Exports (-7.7%) and investment (-15%) are still sharply lower than their pre-GFC levels.

As the supply-side constraints imposed by the March earthquake have been largely resolved, the demand-side growth drivers will become essential from 4Q onwards. In this regard, the outlook for export demand is cloudy because of the uncertainties in global economy surrounding the development of European debt crisis.

Meanwhile, a strong yen, which was a key factor explaining the lagging recovery of Japan’s exports and investment during the post-GFC global upcycle, will continue to be a drag.

That said, manufacturing activity is slowing rather than collapsing. PMI and production forecast index have improved in October after the temporary declines in September when global financial turbulence intensified. The post-quake reconstruction is expected to continue driving investment growth next year. In addition, the adverse impact of the recent Thai flooding on Japan’s exports/production is likely to be limited. Although Japan is Thailand’s largest FDI investor, Japan in itself has a diversified investment portfolio with Thailand accounting for only 3% of its overall ODI.

All in, in order to reflect the downside risks on exports, we have lowered the GDP forecast for 2012 to 2.1% from 2.7%. The new forecast remains about 1ppt higher than Japan’s long term growth average of 1%, taking into account the continued progress of reconstruction next year. The 2011 GDP forecast is lifted to -0.3% from -0.5%, based on the stronger-than-expected recovery in 3Q and the upward revisions in the 2Q GDP data.