Pedestrians cross a street illuminated with neon signs in Tokyo, Japan. (Photographer: Kiyoshi Ota/Bloomberg)

Japan's Economic Growth Streak Set to Restart After Speed Bump

(Bloomberg) -- Japan’s first economic contraction in two years is expected to be only a speed bump on the road to further, yet slower growth.

The economy shrank in the first quarter at an annualized rate of 0.6 percent due to capital investment unexpectedly falling 0.1 percent and flat private consumption. Growth is forecast to resume in the current quarter as global trade and Japanese exports regain traction.

"This will not be a turning point -- but is temporary," said Takeshi Minami, chief economist at Norinchukin Research Institute.

Still, the drop-off offers a reminder of the challenge facing the Bank of Japan as it continues its long-running efforts to achieve 2 percent inflation. Domestic demand remains soft after the two-year expansion, even accounting for temporary factors that weighed in the first quarter of this year, including unusually poor weather.

Japan's Economic Growth Streak Set to Restart After Speed Bump

"Ideally, we should be headed toward an economic expansion led by domestic demand, supported especially by consumption," said Atsushi Takeda, an economist at Itochu Corp. "Unless we have that, it’s difficult to see a world where Japan’s escaped deflation."

Japan’s economy had expanded at well above its potential growth rate for a year, as a strong expansion of exports fueled production and investment, helping to raise wages and inflationary pressures.

The tightest labor market in decades is expected to keep adding upward pressure on wages. An initial reading for March showing the biggest rise in two decades spurred hopes that wage gains may finally accelerate and support robust consumption.

Yet higher commodity prices are already cutting into slowly improving paychecks. Toshimitsu Motegi, Japan’s economy minister, pointed to higher vegetable prices as one factor in the first-quarter contraction.

"Capital expenditure should return, but consumption is still weak, and consumers aren’t in a situation where they can loosen their purse strings,” said Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities Inc.

Exports Key

Japanese exports to a growing global economy will remain key. The International Monetary Fund has forecast global growth of 3.9 percent this year, the fastest pace since 2011. Goldman Sachs economists, led by Jan Hatzius, are even more optimistic, saying this month they are looking for a 4.1 percent expansion.

"The economy still looks fairly healthy after two years of expansion, and the outlook is for a rebound in 2Q, supported by stronger production and exports, as well as faster wage gains," Bloomberg Economics’ Yuki Masujima said.

Industrial production is projected to rise 3.1 percent in April from March, and fall 1.6 percent in May, according to the Ministry of Economy, Trade and Industry.

Still, some see growing risks to the global outlook. Data last month from the U.S. and Europe pointed to a continued slowdown. U.S. manufacturing in April expanded at the slowest pace since July, while Germany’s Ifo business confidence stood at 102.1 in April, down from 103.2 in March. Both service and composite Markit PMI indexes for Europe came in below estimates last month.

"In terms of external demand, the U.S., Europe and China are all slowing down," said Shuji Tonouchi, a senior market economist at Mitsubishi UFJ Morgan Stanley Securities Co."Looking further ahead, there’s concern about trade tensions and there’s uncertainty Trump may say something as the mid-term elections near."

In any case, slower growth is seen for Japan this year. Economists at Morgan Stanley MUFG Securities said in a research note this week that the nation’s economy has reached the "late-cycle phase" of its expansion. It forecast growth of 1.3 percent, down from 1.7 percent last year, and a rebound to 1.5 percent in 2019.

©2018 Bloomberg L.P.