Japan's economy worse than first thought as demand remains sluggish

A Japanese flag flutters at the Bank of Japan headquarters in Tokyo. Japan's economy shrunk in the first quarter

Japan has revised its initial estimates, indicating that its economy shrank at a 2.9% annual rate in the first quarter of the year,

Meanwhile, a survey released on Monday by the country's central bank suggests conditions remain sluggish. Analysts had anticipated this downward revision in GDP data for January-March, attributing it primarily to changes in construction activity data.

The previous estimate suggested a 1.8% contraction in annual terms. The Bank of Japan's quarterly survey revealed a slight uplift in business sentiment among large and medium-sized manufacturers. However, the survey details indicated a weakness in demand both domestically and internationally.

"Across all industries and firm sizes, business conditions held steady at 12, which is on past form consistent with (quarterly) GDP growth of around 0%," Marcel Thieliant of Capital Economics commented on the tankan. "A renewed slowdown in GDP growth this quarter would be consistent with the slump in industrial production firms were predicting for June," he added.

Economists at ING Economics noted that one factor contributing to the slight improvement in overall manufacturing sentiment was the resumption of normal production among automakers. This followed a slowdown in factory lines due to computer chip shortages last year.

The government's recent downward revision for growth earlier this year highlighted that public investment shrank at a rate of 1.9%. Previously, it was thought to have grown by 3%. Private residential or housing fell by 2.9%, rather than the initial estimate of a 2.5% contraction.

Japan's economy saw a meagre 0.1% annual growth in the final quarter of the year, narrowly avoiding two consecutive quarters of contraction, otherwise known as a technical recession. The economy expanded at a 1.8% annual rate in the full year of 2023.

The weakening of the Japanese yen against the US dollar has been beneficial for exporters, who see their overseas profits inflated when converted back into yen. However, it has also significantly increased the costs of commodities and products imported by Japan, particularly oil and gas.

While the US Federal Reserve has maintained high interest rates to control inflation that surged during the pandemic, Japan's central bank has kept its benchmark rate near zero to ensure cheap credit, with the aim of encouraging more spending and investment.

However, price increases have outpaced the rise in Japanese workers' wages, resulting in relatively weak demand and hindering growth in an economy largely driven by consumer demand. The most recent data indicates a drop in household spending in the first quarter of the year, in inflation-adjusted real terms.