Japan economy slips back into a contraction

The first negative growth since 2Q11 looms.

DBS Group Research noted:

The third quarter GDP data (Monday morning) will confirm that the economy has slipped back into a contraction. Market consensus expects -3.4% (QoQ saar), the first negative growth since 2Q11 and largely reversing the positive growth achieved in 1Q12 (+5.3%) and 2Q12 (+0.7%).

The sharp contraction in 3Q as projected in the consensus forecast is not exaggerating. The high-frequency data already showed that industrial production plunged -15.8% (QoQ saar) last quarter.

All-industry output contracted -0.7% (3M/3M saar) as of August, and should have fallen more than -2% in the July-September period, even if assuming services output has maintained an on-trend growth in September and construction output growth stayed above trend. The regression model based on all-industry output and GDP growth (R2=0.91) indicates that the 3Q GDP should be about 0.5% YoY, or -3% QoQ saar.

On the expenditure side, exports should have been a big drag on the 3Q GDP. Real exports fell sharply by -21.9% (QoQ saar) last quarter, due to deteriorating demand from Europe, China and Asia NIEs.

Private consumption, as proxied by retail sales, also didn’t escape a contraction, as a result of the expiration of government subsidies on car purchases. Even the investment indicators (public construction works, housing starts) weakened in 3Q, suggesting that the reconstruction demand may have peaked.

Note that the leading indicators including industrial production forecast (Oct), machine orders (Sep) and construction orders (Sep) continued to decline. Chances are high that GDP will contract further in 4Q, albeit at a more moderate pace than in 3Q.

The recession scenario has not been reflected in the consensus forecast. If the 3Q GDP indeed falls -3.4%, a positive growth of 4% (QoQ saar) in 4Q will be needed for the full year growth to match the current consensus forecast of 2.1% (Bloomberg survey, November). Further forecast downgrades after the release of 3Q GDP next week will remain likely.