Higher export volumes have helped Japan's economy continue its improvement, with growth of 1.0% (annualised) during the December quarter.
This marks the fourth quarter in a row where Japan's economy has expanded due to a boost in export volumes. Corporate capital expenditure also rose 0.9 percent. This growth, however, has been offset somewhat by weaker domestic spending, with some concerned that the benefits of Prime Minister Abe's stimulus package have not yet made their way through to the Japanese consumer. Policy measures can't change everything and our view is that Prime Minister Abe's policy settings appear to be quite well done.
Markets in Japan don't like instability and the fact that investment markets are supportive of the Liberal Democratic Party possibly allowing Prime Minister Abe to run for a third term is evidence of that.
Improving US consumption driving exports
Economic conditions in the US continue to improve, with increased employment and higher wages resulting in a rise in consumer spending. This rise in consumption has lead to an increase in imports, predominantly from Japan and China. There were some concerns within Japan's government around comments made by President Trump during his election campaign, and the impact that his government's shift in fiscal policy will have on Japan's economy.
However, Prime Minister Abe was the first foreign leader to meet President-elect Trump one-on-one, and we see Japan working closely with the US for mutual benefit, which could include Japan taking the lead on the trade relationship. We saw further positive evidence of this with Prime Minister Abe's US visit to meet President Trump in February.
Manufacturing & financials for 2017 growth
We expect that Japan will continue to be an export-driven economy through 2017, with rising volumes suggesting that global demand will continue to improve. Japanese exporters of machinery (predominantly to the US) and electronic parts (mainly computer and smartphone-related parts to China) should be the main beneficiaries of this improved demand. Importantly, this demand could also provide an opportunity for these exporters to expand their production capacity through an increase in capital expenditure, which would also help to drive employment and wages higher.
As this export-led demand helps to drive the domestic recovery in Japan and inflation rises, we would also expect the Japanese financial sector, mainly larger retail banks, to benefit. With Japan being mired in a deflationary environment for close to two decades, local banks have found it difficult to generate consistent earnings growth, especially when lending rates are so close to deposit rates. This new inflationary environment, one that we see extending into early 2018, should allow Japan's banks to drive loan growth and expand home mortgage volumes, an area that has been weak for some time.
3 key drivers for Japan's economy
As we move further into 2017, we expect the continued recovery in Japan's economy will be driven by three factors:
1. Ongoing recovery in global demand
Japan's economy should continue to benefit from rising global demand, with increased volumes (rather than prices) resulting in higher wages/bonuses, which in turn should drive domestic consumption.
While Japan's main export market is China, its most important export market is the US, where ongoing wage increases, employment growth and higher consumer confidence should help to drive the current momentum in export demand.
2. Move to inflationary policy settings
After almost 10 years of zero interest rates, the Bank of Japan now may be looking to increase interest rates to produce inflation. We believe that a reasonable rate rise would be good for the Japanese economy, as it would help to strengthen the banking sector through increased lending, and reduce outflows from investors looking for higher yields overseas.
3. Change in corporate governance
Better corporate governance has been a key tenet of Abenomics, one that has seen the attitudes of corporate managers in listed companies changing. And as one of the largest institutional investors in Japan, we have been helping this process along, with the aim of improving corporate transparency, promoting a new stewardship code and pushing for the appointment of more independent company directors. There is no doubt these corporate reforms will take time, and it is probably too early to say whether they will have the desired result.
What we believe is that, like the Japanese economy, there is movement - and in the right direction.
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