In an unexpected turn of events, Japan's economy has slipped into recession due to weak domestic consumption, leading to a loss of its position as the world's third-largest economy to Germany. The latest data released by the Cabinet Office reveals that Gross Domestic Product (GDP) shrank at an annualized pace of 0.4% in the last quarter of 2023, following a 3.3% contraction in the previous quarter. This decline was significantly lower than market forecasts, as economists had expected a 1.4% growth in GDP during this period.
The downturn in Japan's economy confirms that it now stands as the fourth-largest economy in the world, trailing behind Germany in terms of USD valuation. The main culprit behind the recession was weak domestic demand, with all major categories, including consumer spending, experiencing negative growth. Only external demand, represented by exports of goods and services, managed to make a positive contribution.
Notably, private consumption, which accounts for half of Japan's economy, declined by an annualized 0.9% in the fourth quarter. Japanese consumers battled higher prices for essential items like food and fuel, leading to a continuous decline in consumer spending for the third consecutive quarter. A major factor contributing to the rising costs of living is the weak yen, with Japan heavily relying on imports for 94% of its base energy requirements and 63% of its food.
Furthermore, the depreciation of the yen against the US dollar by 6.6% since the beginning of the year has worsened the situation, making the country's cost of living even higher. Neil Newman, a Tokyo-based strategist at Japanmacro, highlighted that private consumption will likely worsen in January due to the recent Sea of Japan earthquake. Typically, people tend to reduce spending during times of natural disasters.
Capital expenditures also witnessed a decline for the third straight quarter, falling by 0.3%. Additionally, investment in housing by the private sector plunged by 4%. However, despite these challenges, external demand played a vital role in supporting overall growth. Exports surged by an annualized 11% compared to the previous quarter, primarily driven by the weak yen. Inbound consumption, including spending by tourists, also experienced a substantial increase.
Despite entering a technical recession, Japan's markets have remained resilient, as the benchmark Nikkei 225 index advanced by 1.2% and closed above the 38,000 level for the first time since 1990. Some economists believe that the recession may moderate in the coming months. Min Joo Kang, a senior economist at ING Group, expects a rebound in GDP during the first quarter of 2024. She predicts an improvement in private consumption due to stabilized inflation and expected wage growth. Additionally, strong corporate earnings and solid demand for IT are anticipated to boost facility investments.
Analysts at Capital Economics also suggest that the overall business environment may be more positive than what the headline numbers indicate. The unemployment rate reached an eleven-month low of 2.4% in December, and the Bank of Japan's Tankan survey shows that business conditions across all industries and firm sizes were the strongest since the fourth quarter of 2018.
Goldman Sachs expects Japan's economy to achieve 1% growth in the first quarter of 2024. They anticipate a slowdown in inbound consumption but still expect a moderate uptrend. Furthermore, they project a potential rebound of 1.3% in capital expenditure during the same period. Meanwhile, analysts at Capital Economists believe that the fourth-quarter GDP figures may be revised upward in March and suggest that they are unlikely to hinder the Bank of Japan from ending its negative interest rates in April.
Despite the economic challenges, Japan's equity market has remained robust, with the Nikkei index exhibiting a remarkable 28% growth in 2023, making it the best-performing market in Asia. Morgan Stanley has reiterated its positive outlook on Japan's equities, considering it their largest overweight recommendation within their coverage universe. This rally in Japan's equities has primarily been driven by ongoing corporate reforms, improved return on equities, and the boost in profits for Japanese exporters due to the weak yen.
While Japan may have lost its third-place ranking to Germany and entered a recession, there are signs of potential recovery in the coming months. Factors such as stabilizing inflation, wage growth, and positive business sentiment could contribute to the revival of Japan's economy.