International | May 22 2006
By Chris Shaw (Tokyo)
The Japanese economy has recorded stronger growth for the quarter to March 31 than the market had expected, dashing the market’s hopes for an increase in official interest rates when the Bank of Japan meets in June.
GDP growth for the three months was 0.5% in real terms, well above market consensus of 0.3% and equal to an annualised rate of 1.9%, compared to previous consensus of 1.1%.
The government was happy with the result, suggesting it shows the economy continues to strengthen. The composition of the growth supports its positive view, as private sector consumption increased 0.4% compared to expectations of a 0.1% increase, while corporate capital spending rose 1.4% compared to the market forecast of a 1% increase.
Foreign exchange markets were somewhat less impressed though as the GDP outcome reduces the chance of a rate increase in June, which the market had been anticipating since the end of the zero interest rate policy and recent data indicating further increases in US interest rates may be put on hold. Following the release of the GDP figures the yen weakened to around 111.6 against the US dollar after briefly trading above 112, reversing its recent strengthening trend that saw it move below 110 a week or so ago when it seemed the US Federal Reserve was set for a pause in monetary policy.
Clouding the outlook for US interest rates is the latest economic data there, which suggests inflation continues to strengthen and so may require interest rates to move higher than had been expected. As a result, this yield curve in the US has become flatter, which BNP Paribas suggests will put the yen under pressure in the short-term as a flatter yield curve means Japanese investors are less inclined to hedge their currency exposure.
While Bank of Japan governor Toshihiko Fukui said economic data would continue to determine policy, Morgan Stanley notes the process of draining the excess liquidity out of the economy is taking longer than some had expected. The broker suggests it is likely to take several more weeks to achieve the desired level of liquidity, so an increase in official rates is most likely in July rather than June.
Daiwa SMBC Securities agrees, suggesting there is now no chance of an increase in June, its view supported by the GDP deflator figure released at the same time as the growth number. The deflator, which measures the change in prices of all new, domestically produced goods, fell 1.3% for the quarter as domestic prices were held back by high crude oil prices. Daiwa suggests the economic data still supports an increase in rates in future months.
Industry is not as sold on the idea though, given most companies have based their forecasts on a yen rate of 110 against the dollar and so are against an increase in interest rates in the short-term as this would provide additional support to the yen and may force changes to earnings forecasts.
