Japan: Slower Growth Should Prove Temporary

GDP growth in Q3 eased to 1.9% q/q ann. (consensus 1.7%, DBM 2.0%) from 3.9% q/q ann. in Q2. The slowdown in growth was primarily driven by weaker private consumption and exports. Growth in private consumption eased to just 0.4% q/q ann. in Q3 from 2.4% q/q ann. in Q2. Overall investment demand remained strong in Q3 driven primarily by public investments and residential investments, while business investments disappointed slightly. In Q3 net exports subtracted 0.5 percentage point from GDP growth, while inventory added 0.5 percentage points to GDP growth as inventory cuts eased substantially in Q3.

In our view the slower growth in Q3 should prove temporary. Retail sales and auto sales have been strong in recent months suggesting private consumption is poised to rebound in Q4. Indicators for fixed investments have also shown extraordinary strength across the board with particularly domestic machinery orders surging. Finally, the manufacturing surveys do not indicate persistent weakness in exports. Export orders in Japan's manufacturing PMI in October were 53.1, suggesting exports should resume expanding in Q4.

We expect GDP growth in to rebound above 3% q/q ann. in both Q4 13 and Q1 14. In Q1 14 consumers are expected to frontload their purchases of consumer durables ahead of the planned hike in the sales tax in April 2014 and hence it is relatively safe to say that growth will be strong in Q1 next year. However, growth is poised to slow markedly in the wake of the hike despite government stimulus to soften the impact.

Bank of Japan (BoJ) in our view is unlikely to add further stimulus despite the slower GDP growth in Q3. The main message continues to be that Japan is recovering relatively fast and at this stage Abenomics appears to be working Hence, for now BoJ is on auto-pilot. It is important to remember that BoJ is already easing monetary policy very aggressively and despite a strong recovery tapering will not be on the agenda in the near future. On the contrary, growth in Japan will slow markedly from Q2 next year and BoJ could be forced to step up its aggressive monetary easing, just when the Fed will start to scale down its bond purchases. Hence we expect a weaker JPY to remain a major trend next year.

It is positive for the rest of Asia that the two largest economies appear to be in a recovery phase driven by domestic demand. That said, dark clouds could be gathering in the spring next year, as a slowdown in Japan is unavoidable and some leading indicators suggest that China might slow down as well. A simultaneous slowdown in China and Japan could be challenging for Asia.

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