Japan's Economic Recovery Tested by Energy Shock and Fiscal Turn

Japan's economic recovery is being tested by an energy shock and a fiscal turn. Despite achieving substantive inflation and real wage growth, Japan's economy has been underwhelming in recent quarters. In Q2, real GDP rose only 1.1% q/q SAAR, missing estimates, with private consumption contributing nothing to growth. Real household spending has persistently shrunk despite real wage gains, underscoring a dialling back of expenditure as elevated costs of living continue to bite.

The yen's recent weakness and government bond yields' surge reflect rate differentials and broader macro concerns. Elevated crude oil prices have raised the prospect of more persistently high inflation, feeding expectations of tighter monetary policy. Japan's fiscal health is also a concern, with the government's expansionary bias and increased spending likely to lift bond issuance.

A developing phenomenon in Japan is the diving rice prices driven by excess supply. This may present an offset against the inflation-inducing effects of surged energy prices. The government has approved a two-year food tax cut and removed investment limits from ministries' budget requests, fueling concerns about Japan's fiscal position.