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Japan’s economy shrinks more than expected

Japan’s economy contracted more than anticipated in the three months leading up to September, reversing the strong growth observed in the preceding three months until June. The decline of 0.5% in the third quarter, compared to the robust 1.2% growth in the June period, was primarily attributed to slowing global demand and rising domestic inflation.

This decline in economic growth marks the first estimate of a 2.1% annual contraction, following a 4.8% growth in the April-June quarter, surprising market expectations. Both the quarter-on-quarter and annual outcomes were more significant contractions than forecasted, particularly the former, which was only expected to decrease by 0.1%. These contractions represent Japan’s first economic setbacks in a year and highlight the ongoing instability in the country’s growth trend, which has persisted since the emergence of COVID-19 in early 2020.

Economists believe that these substantial contractions, despite being preliminary estimates, may quell the calls from economists, business leaders, and media, especially in the US and Europe, urging a tightening of the Bank of Japan’s relatively relaxed monetary policy stance.

One of the contributing factors to the weaker GDP print was weaker-than-expected domestic capital expenditure, which contracted by 0.6% in the third quarter compared to the second quarter, contrary to expectations for a 0.3% expansion. Additionally, there was a significant decline in private demand, with household spending, retail consumption, and private investment slowing down amidst relatively high inflation and a weakening yen.

Private consumption in Japan saw a 0.2% decline in the third quarter compared to the previous quarter, as both domestic and foreign demand, along with price increases driven by the weak yen, weighed on the economy. In contrast, consumer spending had been robust in the three months leading up to June, contributing positively to economic growth. Private consumption now accounts for more than half of Japan’s annual economic activity and is a pivotal factor influencing GDP movements.

Government spending remained sluggish throughout the quarter, and a widening trade deficit also hindered growth. Japanese exports slowed, while imports remained steady, acting as a detractor to GDP growth. Weak economic conditions in Japan’s major export markets, particularly China, had a spill-over effect on the country, impacting exporters such as automobile and electronics manufacturers. The weakness in China is expected to keep export conditions muted in the coming months.

Japan’s heavy reliance on food and fuel imports continues to limit economic growth, especially in the face of geopolitical disruptions like the Russian invasion of Ukraine and the Israel-Hamas conflict, which drive up import prices, particularly for oil, gas, and coal. This situation has been exacerbated by the rapid depreciation of the yen against a strong US dollar throughout the year.

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