Surprise, surprise: Japan February industrial production declined

The market consensus was 1.3% growth, but the reality was -1.2%.

DBS Group Research said:

February industrial production registered an unexpected decline of -1.2% MoM sa (consensus: 1.3%), a significant payback from January’s 1.9%. The survey of production forecasts suggests that industrial growth will regain momentum in March, however, rising 2.6% (more than the 1.7% projected one month ago). The manufacturing PMI has also picked up to 51.1 in March from 50.5 in February. As such, the temporary slowdown in February will not hinder a strong rebound in industrial production in the whole 1Q (about 15% QoQ saar). This points to real GDP growth of about 3% QoQ saar in 1Q (vs. - 0.7% in 4Q11), well on track to achieve our whole-year growth forecast of 2.1%.

Whereas uncertainties remain over the outlook for exports, we expect output growth to continue the recovery trend driven by domestic demand. Machinery investment by manufacturers that was delayed by last year’s earthquake disaster and European crisis is recovering. There is also pent up demand from consumers who had put off purchases of durable goods during the economic downturn last year (retail sales: 2.0% in Feb). More importantly, the post-earthquake rebuilding activities should provide a support to construction investment, especially from 2Q onwards after the implementation of the third supplementary budget (housing starts: 11.6% in Feb).

Thanks to the recovery in demand, deflation is moderating. Headline CPI and core CPI respectively rose 0.3% YoY and 0.1% in February. Core inflation excluding all food and energy also turned less negative to -0.6% (-0.9% in Jan). Growth recovery and the easing of deflation should in turn reduce the pressures on the BOJ to loosen policy (no policy change is expected at next week’s BOJ meeting). The improvement in economic data, lowered expectations of BOJ easing, together with the likelihood that the trade balance has passed the worst phase should also help stabilize the yen exchange rate, for now.