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Economics
Japan's economy is at critical moment to transform from 3 decade stagnation to "a mild nominal growth" period, which should accompany policy normalisation
Japanese economy is now at critical juncture for "Nominal Renaissance"
Japan's economy has stuck to stagnation with effectively no nominal GDP growth in past three decades after the asset price bubble burst in the early 1990s. However, we now see signs that nominal growth is returning, with a shift in society's expectations (social norm) of wages and prices. We call this transformation a "nominal renaissance." While this dynamic may not continue in the event of unexpected negative shocks, such as a severe recession in the US and/or China, our base case looks for this transformation to be sustained despite global headwinds (US mild recession and high uncertainties in terms of geopolitical risk).
Real GDP to grow at or above potential growth at around 0.5% in 2024-2025
We believe real GDP probably grows at 1.8%y/y in 2023. We think a notable slowdown to less than 1% is inevitable in 2024, particularly with our US outlook, which looks for a mild recession in the middle of the year. Still, we think around 1% growth will resume in 2025 with the recovery of global demand. This expected pace of real GDP growth may not sound impressive, but is still higher than the potential growth rate of around 0.5%, which is likely to accelerate somewhat in coming years with an increase in investment, especially in digitalisation and human capital (reskilling).
CPI inflation to slow but underlying inflation to rise with higher wage growth
We expect a deceleration of both core-CPI (excl. fresh foods) and core-core CPI (excl. fresh foods and energy) from 2.8%y/y and 4.2% in September this year to 1.8% at the end of 2024. The main driver of this disinflation is a slowdown in goods inflation, along with lagged reflection of falling import prices. However, we are relatively optimistic on the positive feedback on wage growth and price hikes. We expect wage hikes for whole workers will hover above 2% though 2024, and this will support inflation, especially in services. This positive feedback also lifts inflation expectations, in our view. With this higher inflation expectation, we expect core-core CPI inflation to stay close to 2% in 2025 despite the slower GDP growth and JPY appreciation in 2024.
Policy normalization is coming: BoJ to hike overnight policy rate in April 2024
Our BoJ call looks for a hike in the overnight policy rate from the current -0.1% to 0% in April 2024, followed by a 25bp hike in July, then a pause until April 2025 with the US recession and the Fed's aggressive rate cuts. After that, we expect the policy rate to be raised gradually to 1.0% at end of 2025. Soft Yield curve control is likely to be maintained until April 2025, in our view. The government has put together another fiscal package in November this year. This may sound expansionary, but the size of the package is smaller than similar packages seen through the pandemic. The fiscal deficit is expected to be reduced in coming years mainly with higher revenues due to higher nominal GDP growth.
Risks: failing or overshooting
Still, a smooth normalisation in both monetary and fiscal policy looks challenging as we shift from no nominal growth to a decent growth regime. If both tighten the economy too early and too much, the transformation to a new regime could fail. On the other hand, if inflation or expectations of inflation rise faster than the BoJ and markets currently anticipate, market yields would rise faster and more significantly. A sharp increase in yields would threaten the BoJ's finances, fiscal sustainability (including the risk of downgrade in sovereign ratings), and financial system stability.
We expect central banks to commence rate-cutting cycles in 2024. In our view, government bond markets are overpricing the risk that high interest rates will represent the new normal, and we expect yields to fall in 2024.
Debt is likely to continue to rise, fixed income volatility is likely to be higher in the decade ahead, and we think it unlikely that rates and yields will return to pandemic-era lows. But we do not believe that rates or yields are now in a structural uptrend. Debt, demographic, and productivity trends, along with a gradual restoration of central bank credibility, mean we expect rates and yields to settle at lower levels than today’s.
We expect the strength of the US economy in 2023 to give way to slower, though still positive, growth in 2024 as consumers face mounting headwinds. We expect European growth to remain subdued, and China to enter a “new normal” of lower, but potentially higher-quality, growth.
Generative artificial intelligence isn’t a new concept—the broad idea has been around since the 1960s, and the transformer architecture that makes it more effective was detailed in 2017. But the launch of ChatGPT has shown its potential impact when combined with a platform with strong consumer adoption. Currently, we see AI-related opportunities across a range of software, internet, and semiconductor stocks.
A new normal is coming into view for China. Constraints on old growth drivers and a new focus on higher-quality growth will likely temper its GDP growth toward a 4–4.5% pace over the next decade. For investors, this means a greater long-term focus on sectors aligned with the country’s efforts to boost its tech self-sufficiency, localize mass consumption, upgrade its high tech and industrial sectors, and lead the global green transition.
