Japan’s economic landscape is cracking at the seams. Today our nation is faced with worsening industrial production and now, we’re seeing faltering auto sales. The newly released data for November confirm our fears, with a shocking 2.6% decline in industrial production from the month before. Auto production fell sharply, down 7.2% – the first drop in four months. These numbers, combined with other bullish economic metrics, suggest that the Bank of Japan (BoJ) will be leery to raise interest rates aggressively. Otherwise, they can delay all of the sort of big changes until 2026.
Setting the stage for these developments is an anxiety tinged sense of optimism about Japan’s economic resilience. Almost every time this country has faced outward challenges in targeted areas. Retail sales increased by 0.6% m/m in December, the third straight month of increases. As the BoJ considers further rate rises, it should consider the effects of previous hikes and recent economic performance.
Declining Industrial and Auto Production
Japan’s industrial production printable fell by a significant 2.6% in November, foreshadowing further cracks in the manufacturing foundation. The automotive industry experienced a significant downturn, posting a 7.2% decrease in production. This is the first drop in four months. Analysts say that this recession could be blamed on a numbered list of reasons, such as supply chain problems and just a general loss of global demand.
Weakness in auto sales only adds salt to the wound, with logics declining 2.6% in November. The automotive industry is the engine of Japan’s economy. If that production and sales drop for a long enough time, the whole national economy could experience the ripple effect.
Additionally, the historic drop in Chinese tourists is expected to drag retail sales down when December figures roll in. Japan’s retail industry has come to depend on tourism. A big dip in tourist activity may present big challenges for businesses that rely on that consumer spending.
Future Interest Rate Speculation
The Bank of Japan is feeling more than the usual pressure to raise interest rates after its recent moves in that direction. Current expectations imply that the BoJ will increase short term interest rates to 1.50% by the end of 2027. Looking at the less rosy economic picture that we have seen lately, it looks like the BoJ needs to take a more careful and gradual approach. The bank indicated it may conduct a deeper analysis of the effects of rate hikes already implemented before deciding what further action to take.
The BoJ is intensifying its efforts to track core inflation trends more carefully. They expect all these trends to start slowing down and converging back down to 2%. This revision is consistent with further moderation of headline inflation to 2.0% y-o-y by December. Still, that leaves rate hikes on the table. Their timing is unknown, with the month of October being proposed as a possible window in which to act.
Japan’s major labor unions are demanding that wages increase by more than 5%. This provocation points to further conversations around equitable compensation as we face an ever-increasing cost of living. If successful, these wage increases could help inject billions of dollars into consumer spending and other economic activity.
Government Bond Issuance and GDP Projections
To adapt to changing economic circumstances, the Japanese government will change its strategy on bond issuance.… to step up their efforts to limit sales of extremely long Japanese government bonds (JGB) by the government. Simultaneously, they are increasing the pace of their 2-year and 5-year bond issuance. This change is a positive step toward responsively trying to address the new reality of fiscal policy with respect to today’s economic realities.
Japan’s GDP has experienced a few bumps in the road recently, but future projections are promising. In the fourth quarter, it will likely pick up by 1.6% q-o-q at annualized terms. The expected growth is further evidence that our economy is standing strong in the face of adversity. Additional impulse will rising winter bonuses contribute much to overall consumption growth.
The yields on short-term JGBs rose consistently throughout December in the wake of the Bank’s latest policy rate increase. These trends can have a second-order impact of driving investor behavior as they try to keep pace with a rapidly changing economic environment.