Rising geopolitical tensions over territorial disputes in the South and East China seas are raising the risk of a military clash between China on one side and the US, Japan, Vietnam, and the Philippines on the other. This could quickly escalate into a major global crisis.
Recently revised Q115 real GDP figures and a number of leading indicators point to stronger growth in 2015 as a whole, and we have revised up our forecast to 1.2% from 0.8% previously. However, the distortions created by ongoing monetary and fiscal policies suggest that the recovery will not be sustainable, and we expect real GDP growth to fall back to 0.7% in 2016.
Underlying inflationary pressures are building in Japan despite declining headline CPI, and we believe that the BoJ will refrain from expanding its QE programme in the near term. However, a still-high fiscal deficit and the upcoming huge rollover of government bonds will require the BoJ to buy JGBs as the lender of last resort, further expanding its balance sheet.
Japan's fiscal position shows no sign of the kind of material improvement that would reduce our concerns of a future fiscal crisis. We remain bearish on 10-year Japanese government bonds.
Japan's largest banks continue to expand overseas amid narrow net interest margins domestically. We expect this trend to continue, but note the risks posed to the sector from possible yen appreciation. From a medium-term perspective we continue to see banking equities outperforming the Nikkei, owing to relatively cheap valuations.
The surge in Japan's current account inflows and concomitant financial account outflows is buttressing the country's already huge stock of overseas assets. We expect these assets to continue growing as Japanese businesses increasingly look overseas for investment opportunities, to the detriment of the domestic economy.
After a 40.0% peak-to-trough decline, we believe the yen has likely already depreciated enough against the US dollar to account for the higher rate of inflation that is likely to ensue over the coming years. However, it is difficult to forecast strength while the government shows little urgency with regards to tackling the county's huge fiscal debt burden and the BoJ continues to accommodate with debt monetisation. We believe the risks are evenly balanced and expect USD/JPY to remain range bound over the coming months.
Major Forecast Changes
We have revised up real GDP growth for 2015 to reflect the recent puck-up in growth momentum. Lower oil prices and rising asset prices have helped to trigger a cyclical rebound in the economy, which should see real GDP growth come in at 1.2% in 2015, versus our previous forecast of 0.9%. That said, we maintain our bearish long-term outlook, forecasting growth of just 0.7% over the long term owing to deteriorating demographics and the burden of the government's high debt load.
Key Risks To Outlook
Successful Trans Pacific Partnership (TPP) negotiations have the potential to open up a number of Japan's industries to foreign competition and investment, improving the country's business environment and stimulating long-term growth.
On the downside, the ongoing quantitative easing programme, in combination with high levels of government spending, are undermining productive investment in the economy due to the distortion of interest rates. The risks is that real interest rates return to positive territory in a rapid fashion, which could result in large numbers of bankruptcies and leave the government in a difficult position to finance its huge debt burden.
|Real GDP growth, % y-o-y||1.6||0.0||1.2||0.7|
|Nominal GDP, USDbn||4,918.9||4,610.4||4,155.1||4,223.1|
|Consumer price inflation, % y-o-y, eop||1.6||2.4||1.1||2.2|
|Exchange rate JPY/USD, eop||105.31||119.78||122.00||123.00|
|Budget balance, % of GDP||-9.4||-7.9||-7.3||-7.0|
|Current account balance, % of GDP||0.7||0.5||2.3||2.1|