East Asia Econ

Consumer confidence improved again in May. That offsets the significance of the fall in April retail sales. But while employment sentiment in the consumer confidence survey also improved, it is still noteworthy that official labour market data through April continues to feel soft.

The flash Markit PMIs in May were strong, showing the strong rise in economic momentum of the last couple of months is sustaining. According to the press release from Markit, price indicators were also firm, albiet not quite as heady as sentiment around activity.

In his first speech as governor, Ueda Kazuo reiterated the BOJ's view that the current strength of inflation will prove transitory, and that the bank will be patient. To us, the case for this time being different is strengthening, but as yet has a missing component: labour market tightening.

Japan's cycle is gaining momentum, led by a recovery in services. In this context, the recent softness of the labour market data looks even odder. The BOJ's outlook report wasn't concerned, highlighting this year's strong shunto round. This will keep upwards pressure on core CPI.

As widely expected, the BOJ meeting today didn't announce changes in policy. Data releases also showed consistency, with Tokyo inflation in April still accelerating but the labour market in March going sideways.

Decisions about changing the policy framework are interwoven with deciding that there really is a generational shift in inflation occurring. Given the BOJ's history of premature tightening, that requires almost Jedi-like levels of bravery, and we doubt the bank is ready to reach that conclusion yet.

Core inflation accelerated in March. The feed through from the big fall in import price inflation from mid-22 is probably only about to start, so the BOJ's view that headline CPI will ease may still prove correct. But the strength of core makes it tough to argue that there is no domestic inflation.

The Economy Watchers and consumer confidence surveys for March suggest Japan's economic recovery is finally gaining momentum. The BOJ will likely have to recognise that at its forthcoming meeting, which will raise market expectations of a shift in YCC.

Underlying wages are rising by a bit over 1% a year. That is the highest since the 1990s, but doesn't yet show signs of accelerating. That should change in the next few months as the further post-covid normalisation of the hospitality industry increases demand for labour.

The BOJ quarterly Tankan doesn't point to much change in economic momentum. But it does suggest non-manufacturing is on the up, with sentiment, employment and output prices all rising. This is further evidence of inflation broadening, increasing the probability of Japan's real exit from deflation.

Japan's economy is recovering and inflation broadening, but indicators aren't all aligned yet. Being clearly bullish on equities and bearish on bonds is still based on developments that should happen in the future, notably the further tightening of the labour market.

The rise in February services PPI inflation offers more evidence that Japanese inflation is broadening away from import prices and commodities.

Headline CPI inflation fell back in February. That was because of government subsidies, but there's now also downwards pressure from falls in JPY commodity prices. However, there's also evidence that inflation continues to broaden away from just import prices and commodities.

Imports have fallen, allowing the trade deficit to narrow. Exports are going sideways. Our regional export leading indicator has started to lift, which should benefit Japan. But for export performance to improve materially, Japan's auto sector needs to perform more strongly.

The BSI reinforces recent themes: that growth should be a bit stronger in the next few months, and that the labour market should finally get back to pre-covid levels of tightness.

The Economy Watchers Survey was better again in February. So maybe the recovery is a bit stronger than our last assessment of 6/10. But Q4 GDP growth was weak, so the recovery is still young, and so it seems unlikely the new BOJ leadership will want to move policy too much.

Wage growth in Japan slowed in January, as the benefit of year-end bonuses disappeared. Underlying wage growth is running a bit over 1% YoY, stronger than history, but not enough to produce CPI inflation of 2%. In this sense, the BOJ doesn't have much room to shift policy.

Inflation is finally falling, and the labour market is tightening. But the easing of inflation is because of government subsidies, and employment is still below pre-pandemic levels. So, the recovery is gradual and vulnerable to shocks, with the obvious one being another sharp move higher in $JPY.

CPI inflation rose again in January. That's probably the peak, with utility subsidies kicking in from February, and import prices easing. Still, it is no longer reasonable to argue that inflation isn't broad-based, even if it hasn't yet become fully domestically generated.

It now falls to Ueda Kazuo to try to diffuse pressure on YCC. But he also needs to find a way to nurture economic recovery from covid. This week's GDP data suggests again that this process still has a long way to go, and would risk being short-circuited by premature BOJ tightening.

Import inflation has now fallen from almost 50% YoY to under 20%, suggesting headline CPI inflation drops from 4% to under 2% in the coming months.

The Economy Watchers survey has been volatile since 2019, so caution is warranted. But the survey was firm in January, led by non-manufacturing. That's important when post-pandemic normalisation of Asian travel has the potential to boost hospitality, driving the unemployment rate below 2019 lows.

Wages and consumption are trending up, but progress in incremental. Earnings grew more strongly in December 2022 than in any month since 1997. That is welcome, but is mainly the result of bonuses. Separate consumption data weakened in December, but that is probably payback after a strong Q3.

The two big hopes for Japan's economy in 1H23 are a decline in inflation that lifts domestic spending, and a normalisation of Asian travel that boosts tourism. December unemployment and January consumer confidence suggest both dynamics might be in play, but not yet powerfully.

Tokyo CPI rose again in January, and on a headline basis is now above 4%. Leading indicators continue to suggest the peak should be close, with this week's services PPI for December falling.