Is Japan's Long Running Economic Expansion Finally Drawing to a Close?

Despite the relatively healthy performance turned in by the Japanese economy in Q1 2007, the signs are that the impact of rising food and energy costs and slowing global economic growth (and hence demand for Japanese exports) are now taking their toll.

``We think April-June real GDP is at risk of zero percent growth'' as exports and consumer spending weaken, Takehiro Sato, chief Japan economist at Morgan Stanley in Tokyo. ``Momentum in capital investment is already lagging.''

Japan's services sector, for example, bounced back slightly in March as consumers spent more to repair their cars, play golf and go to the theater. The tertiary index, which is a gauge of household and businesses spending on items ranging from phone calls, to power and transportation, increased 0.3 percent from February, the Trade Ministry said today in Tokyo, The uptick however followed a revised 1.6 percent decline in February, and as we can see from the chart below we are still below the level reached in January, and year on year the index is virtually unchanged.





Indeed tertiary demand, which accounts for about 60 percent of the economy, fell for the second consecutive quarter in the three months ended March 31, producing the first back-to-back decline since the economy emerged from a recession in 2002.



Evidence that households are cutting back on spending is now becoming pretty general and indeed household spending fell at the fastest pace in 15 months in March as prices of frequently purchased goods from milk to eggs climbed at an annual rate of 3.2 percent , more than double the growth in wages in that month.





Consumer confidence also dropped to a five- year low in April.





And consumers won't be able to count on higher paychecks to offset the impact of inflation because companies are unlikely to raise pay at a comparable rate as surging raw-material costs erode profit margins. In just one sign of the times example Japan Airlines announced last week that it was going to cut salaries and other benefits by 5 percent because profits are likely to drop 44.5 percent this year on fuel costs.

Meanwhile the Bank of Japan today kept interest rates on hold at their first meeting following a substantial reduction in their growth forecast. Today's meeeting was also of note since it marked the effective shelving of a two-year policy of seeking to raise interest rates.

``Japan's economic growth is slowing, mainly due to the effects of high energy and materials prices,'' the central bank said.

Exports rose at the slowest pace in almost three years in March.



At the same time production fell the most in at least five years in March.




The Bank of Japan dropped a call for gradual rate increases from its twice-yearly economic outlook published on April 30 and cut its estimate for this fiscal year's growth to 1.5 percent from 2.1 percent. It also forecast that consumer prices excluding fresh food will climb 1.1 percent, raising its inflation projection from 0.4 percent.

Over the last two years the economic outlook has consistently said that the bank would pursue higher interest rates, repeating the assertion that borrowing costs need to rise gradually as long as the economy keeps growing and prices remain stable. This has now been dropped but the report did retain a warning that continuing to keep rates at their current low levels could cause excessive investment and hamper growth in the long run.

Russia's Growing Inflation Headache

Russia's inflation rate rose to an annual 14.3 percent in April, the highest since April 2003, led by rising food costs. The inflation rate rose from 13.3 percent in March, while prices rose 1.4 percent in the month, compared with 1.2 percent in March, the Moscow-based Federal Statistics Service reported last week. Prices have already increased by 6.3 percent so far this year (January - April).



Food prices increased a monthly 2.2 percent in April, according to the statistics office. Bread prices rose 6.4 percent and sunflower oil prices increased 8.6 percent in the month.

Russia, which is the world's biggest energy exporter, is struggling in what now appears to be a vain attempt to reduce the inflation rate to 10 percent this year as food and energy prices and rising wages and living standards take what appear to be a relentless toll. Russia's inflation rate reached 11.9 percent in 2007, topping the government's 8.5 percent target rate by a good margin.


Letting The Ruble Rise


As a result of the difficulties which the Russian government are having containing prices speculation is now mounting that one of the first policy decisions Dmitry Medvedev take after he's sworn in as Russia's new president this week will be to allow a stronger currency.


Merrill Lynch, Goldman Sachs and Deutsche Bank are forecasting the currency may rise by as much as 4 percent over the next six months. They suggest the central bank will come under increasing pressure to let the ruble appreciate to try to stem inflation even if it risks damping profits of oil and energy exporters, which according to Merrill Lynch currently fund more than half of the federal budget. The last time Bank Rossii allowed the ruble to strengthen was last August, when the inflation rate was "only" 8.5 percent. It's now up to 14.3 percent, and in all probability is still be rising.

The central bank attempts to "steer" the value of the ruble, setting the price against a currency basket made up of 0.55 dollars and 0.45 euros. It allowed the currency to appreciate against the basket three times last year, by a total of about 1.3 percent. The central bank also estimates the pass-through rate - or the rate at which and increase in the ruble would cut inflation - to be 0.3, that is to say a 1 percentage point increase in the ruble against the currency basket would cut inflation by 0.3 percentage points.

The downside of a stronger ruble for Rosneft is that it may diminish profit because half the oil produced by the company is sold into the dollar-denominated export market.

Interest rates aren't changes are thought not to as effective in controlling inflation in Russia as in more developed economies since Russia doesn't have a highly developed consumer-credit market, with mortgages and credit cards little-used outside larger cities, while the corporate sector has access to foreign currency denominated loans carrying lower interest rates which may not look especially risky given the background of potential ruble rises.

Many observers now fear that Russia is riding so high on rising oil and gas prices that it has little incentive to diversify economic activity beyond commodities. The energy industry produced more than two-thirds of the nation's export earnings and more than a third of the state's 2007 revenues, which totaled $315 billion.

The government has ignored advice from the World Bank and other organizations to invest in other industries, start-up companies and infrastructure. Instead, the central bank has amassed $530 billion in gold and foreign-currency reserves; Putin has put $130 billion of that in a sovereign-wealth fund that would provide no more than a two-year cushion if energy prices fall.

``This route may lead to a dead end,'' Economy Minister Elvira Nabiullina said at a Finance Ministry meeting last month. ``We no longer have the advantages of a cheap ruble, cheap labor'' after a decade of average annual economic growth of 7 percent that pushed up wages and the currency, making Russia less competitive.

Russia, the world's biggest energy exporter, has expanded an average of about 7 percent a year since President Vladimir Putin, 55, took office in 2000. During that time, the price of oil has risen almost fivefold to a record $119.93 a barrel. The economy will grow 6.6 percent this year, more than five times the 1.2 percent average of the G-7, according to Merrill Lynch.

German IFO Business Confidence April 2008

Business confidence in Germany (as measured by the IFO index) fell back in April (reinforcing the impression given by the recent ZEW index reading) as record oil and food prices stoked inflation, weakening further already weak domestic demand, and external conditions - and hence the outlook for exports - continued to deteriorate.

The Munich-based Ifo institute said its business climate index, which is based on a survey of 7,000 executives, fell to 102.4 from 104.8 in March. That's its lowest level since January 2006.



The sub component measuring German executives' assessment of the current business situation declined to 108.4 in April from 111.5 in March, while the indicator measuring expectations for future business dropped to 96.8 from 98.4.

Confidence also fell in France, with sentiment the among the 4,000 manufacturers surveyed by Insee, the Paris-based national statistics office, sliding to a 16-month low of 106 from 108.

In Italy, consumer confidence also held near its lowest level in four years, the Rome-based Isae Institute said today, while in Belgium, business sentiment dropped to the lowest level in more than two years in April.

A sharp slowdown in Europe will damp inflation and force the European Central Bank to cut interest rates within six months, the IMF's European Director, Michael Deppler, said earlier this week.

The ECB is reluctant to follow the U.S. Federal Reserve in cutting borrowing costs to bolster the economy, stressing its concern that inflation may get out of hand.

Food-price inflation in Europe accelerated to 6.2 percent in March from 5.8 percent in the previous month. That's the highest since the European Union's statistics office, Eurostat, began the current data series in 1997. The prices for rice, soybeans, wheat and corn have all risen to records this year. Crude oil also reached a record of $119.90 a barrel on April 22.

At the same time ECB policy makers including Germany's Axel Weber and Juergen Stark have suggested the ECB's current benchmark rate of 4 percent may not be high enough to combat inflation.

PMI Flash Estimates

The April preliminary estimate for the German purchasing managers index for manufacturing came in at 53.6 on Wednesday, significantly below economists' expectations of a 54.8 reading.



On the other hand, the services figure surprised on the upside with a figure of 54.6. The consensus had called for a reading of 51.6.



In March, the manufacturing and service PMIs came in at 51.8 and 55.1 respectively.


The euro zone composite PMI was recorded at 51.9, up from both the previous month’s reading of 51.8 and the expected reading of 51.5, but the eurozone manufacturing sector index, which brings together a number of indicators, dropped sharply, from 52 in March to 50.8.

According to a Danske Bank research note, the most conspicuous part of the euro zone PMI manufacturing results was the fall in the new orders index from 50.9 to 48.6, its lowest level in nearly three years.

Manufacturing new export orders contracted this month for the first time in almost three years, according to purchasing managers’ indices for the 15-country region. Even Germany, where overseas sales have appeared resilient, saw a sharp slowdown in growth rates.

“The effects of the euro are becoming increasingly widespread as long-term supply contracts are renegotiated,” said Chris Williamson at NTC Economics, which releases the figures with the Royal Bank of Scotland. So far, eurozone businesses, especially in Germany, have largely shrugged off the euro’s rise.

The results will worry policymakers because the effects of currency appreciation typically take many months to feed through. This week, the euro rose above $1.60 for the first time since its launch almost 10 years ago – suggesting a further slowdown in exports is in the pipeline.


France’s new export orders were already below 50 in March, but the latest figures for Germany showed a fall from 54 last month to 51.6 in April. The survey in-cludes trade between eurozone countries, but NTC Economics said responses by companies suggested the euro’s value was becoming increasingly an issue.

Germany's economy has performed relatively well in recent months. The economic slowdown is most pronounced in Spain and Italy, with France in between. Germany's overall PMI index rose to 55.0 in April from 53.0 in March. But the French composite PMI dropped to its lowest level since November 2004, dipping to 53.9 in April from 55.9 in March.

With a stubbornly elevated rate of inflation and a weaker rate of growth, the European Central Bank's policy dilemma is worsening, leaving the central bank's rate-setters with little room to maneuver.

The worsening outlook for manufacturing contrasted with bullish euro-zone industrial order inflow reported for February, when bookings rose 0.6% month-on-month and 9.9% year-on-year, according to Eurostat.

Italian Consumer Confidence April 2008

Italian consumer confidence rose slightly (but ever so slightly, see chart below) in April - holding near its lowest level in almost four years as an economic slowdown prompts households to cut back on spending. The Rome-based Isae Institute's index, based on a survey of 2,000 families, rose to 99.8 from a 99.0 last month. The March reading was the lowest since May 2004.




Rising food costs and oil prices near the $120 a barrel mark are stifling consumer spending as wage growth stagnates. Even with economic growth slowing, higher energy and commodity prices have pushed the inflation rate to its highest in at least 11 years, further sapping optimism.



The Italian economy may have already slipped into recession in the first quarter - or even in the last quarter of 2007 . Italy has suffered three recessions between 2001 and 2005. According to the IMF Italy will grow by 0.3 percent this year, half the pace of the U.S. and a fraction of the 1.2 percent growth rate anticipated for the entire euro region. Making this the 12th year in a row that Italian growth has been below the average rate for the euro-region.



Italian retail sales fell at the fastest pace in four years in March as campaigning for national elections drew to a close and added to concern about the economic outlook, the Bloomberg purchasing managers index showed.





For a much fuller study of the issues which lie behind the present economic malaise in Italy see my full-study "Italy's Economy Going Into The 2008 General Election" post.