01 October 2014

After a spate of disappointing recent economic data, next week’s BoJ Policy Board meeting looked set to attract more attention than usual, with some observers looking for an admission that economic events since the tax hike have panned out worse than expected and/or signs of an imminent policy shift. But if it trusts the findings of today’s BoJ Tankan survey, the Policy Board won’t be alarmed. Key messages included the following:

• Gradual recovery remains likely, even for manufacturers.

Despite the drop in IP in August to the lowest level since June 2013, and an inventory overhang, the Tankan’s headline index for large manufacturers beat expectations, rising in Q3 (up 1pt to 13, almost double the average for the past two years) and forecast to remain stable in Q4.  Large non-manufacturing enterprises, which have enjoyed firmer growth over recent years, were admittedly more downbeat. Retailers, wholesalers and real estate firms revised down their assessments, so the headline index for the sector fell more than expected, down 6pts in Q3 also to 13. But it is forecast to edge up again in Q4 to 14, the average of the past two years. Indeed, the Tankan suggests that business conditions remain more favourable than the norm for manufacturers and non-manufacturers alike, and for firms large and small.   

• Profits look resilient.

  Despite subdued demand in the wake of the tax hike, the profit outlook remains upbeat, with large manufacturers and non-manufacturers revising up their expectations for the current fiscal year, forecasting a drop of just 3% in profits from last year’s elevated levels. With the survey suggesting that firms are planning on the basis of a conservative exchange rate assumption – just ¥100.6 over the coming six months in marked contrast to the ¥110 level touched earlier today – the profit forecast should be subject to upside risks too.

• Capex plans have been revised up.

  With the profit outlook firm and enterprises having revised down their assessment of spare production capacity, capex plans for coming quarters were revised up. Perhaps most notably, fixed investment spending by large manufacturers is expected to rise 13.4% in FY14, which would represent the strongest performance in nine years. Large non-manufacturers also revised up their capex plans, by more than 1pt to 6.3%, which would be an eight-year high. 

• Wages should continue to rise.

  Manufacturers and non-manufacturers alike, and firms of all sizes, are now reporting staff shortages. And they expect those shortages to persist. The labour market is already tight by recent standards, with the unemployment rate down to a 16-year low and the job-to-applicant ratio now the highest since 1992. So, assuming the continued economic recovery implied by this survey, further gains in regular wages – which rose for the third consecutive month in August – should be in store. That, of course, should spur a gradual increase in consumption growth. And it should also help provide a further positive impulse to prices. 

• Inflation to remain below target.

  The BoJ’s assessment that underlying inflation would remain firm above 1%Y/Y throughout the summer has been vindicated, and the weaker yen will also push up prices of imported goods over coming months. But while the BoJ’s composite output gap indicator derived from Tankan indices suggests that capacity constraints in Q3 were the tightest since early 1992, there is still little evidence in the survey that they are generating the broad-based price pressures likely to be required to push inflation close to the 2% target. According to the Tankan, fewer large non-manufacturers increased their prices in Q3, while small non-manufacturers were forced to cut prices in the past quarter. Those firms are a touch more optimistic about pricing power in Q4. But, exposed to more intense competition, on balance, manufacturers reported that their prices also declined, and at a steeper pace than of late, in Q3 and see little respite in Q4.     

Overall, therefore, while we expect the BoJ to revise down its economic forecasts later this month, there was nothing in the Tankan to suggest the need for a radical reassessment of the outlook. The BoJ will feel relatively confident that moderate economic recovery and continued positive (albeit sub-target) inflation remains the most likely scenario. And so, it also seems highly unlikely to signal that additional stimulus will be in the offing soon. So, all in all, the forthcoming Policy Board meeting might well prove somewhat less eventful than many observers had originally thought.