Japan’s economy slips into recession

Toward the end of last year, the Japanese economy unexpectedly contracted, defying expectations of modest growth and pushing the country into a recession.

The fourth-quarter economic downturn in Japan was attributed to a slowdown in spending by both businesses and consumers, who were contending with inflation at four-decade highs, a weak yen, and rising food prices.

As anticipated, Japan’s economy, marginally smaller than Germany’s, slid one rank lower, becoming the world’s fourth-largest economy by the end of the year.

On an annualized basis, gross domestic product contracted by 0.4%from October to December, following a revised 3.3% decline in the preceding three months. Economists had projected a growth of around 1% for the fourth quarter.

These figures cast a shadow on Japan’s economic prospects. Although corporate profits are at record levels, the stock market is thriving, and unemployment rates are low, consumer spending and business investment, crucial drivers of the economy, are lagging.

Economists described the economy as “polarized” due to higher prices. While corporate profits soar, pushing up the prices of goods, wages have not kept pace, causing consumers to hesitate in spending. The pivotal question revolves around whether Japanese workers can secure a substantial increase in wages this year.

With two consecutive quarters of negative growth, the economy technically enters a recession, pending final figures. A significant upward revision could potentially negate the recession designation.

The soft economic data also adds complexity to an imminent decision by the Bank of Japan regarding the country’s first interest rate hike since 2007.

Japan’s central bank kept interest rates low

Japan’s central bank has persistently maintained policies aimed at keeping interest rates low and stimulating spending, a lingering strategy from its prolonged battle against deflation. Speculation among economists suggested that the central bank might change course as early as April if the economy exhibited signs of strength.

It is unknown if the disappointing fourth-quarter figures would deter the Bank of Japan from ending negative interest rates in April. Despite projecting slow economic growth this year, the central bank may proceed with its intended policy shift.

One ongoing concern for the central bank is the enduring weakness of the Japanese yen. While the weakened currency raises the cost of imported goods, contributing to inflationary pressures for consumers, it benefits major Japanese companies by boosting their foreign earnings when converted back to yen.

The Bank of Japan’s steadfast policies, in contrast to rate hikes by the European Central Bank and the Federal Reserve, have contributed to the yen’s weakness. This has attracted global investors who borrow yen at low rates in Japan and invest the funds in higher-yielding currencies like the dollar or euro in the West.

Japan could fall further in the ranking

Economists predict a potential contraction in the domestic economy for the first three months of this year due to disruptions caused by a major earthquake in January in western Japan, a manufacturing-rich region. Such setbacks could further dampen consumer sentiment.

The release of year-end gross domestic product numbers also marked Japan’s slide to the fourth-largest economy, relinquishing its position to Germany in terms of U.S. dollars. Germany, however, is grappling with its own economic challenges, including rising energy costs following its decision to cease buying cheap Russian natural gas and oil after the Russian invasion of Ukraine.

Looking ahead, Japan faces the prospect of losing its rank to other growing economies, particularly India, given its shrinking population in contrast to India’s robust demographic growth.