On July 12, Toshihiko Fukui, Governor of the Bank of Japan said that slow growth in the second quarter would not determine the outcome of the August 22 and 23 monetary policy meeting. However, the unexpectedly big slowdown in real GDP, from a revised 3.2% annual rate in the first quarter to 0.5% annual rate in the second quarter may weaken his resolve to raise the key overnight lending rate from 0.5%.

The disappointing report was the result of a decline in fixed capital formation, a deceleration in net exports of goods and services and private consumption. In addition, private sector inventories declined in the second quarter. The changes in the major components of real GDP are shown in the first chart.

While the GDP report gives little support for a rise in interest rates a determined BOJ could cite the rise in deflator for domestic demand, the preferred measure of inflation.The second chart shows the year to year changes in the total GDP deflator and those in the Domestic Demand Deflator. The total deflator has yet to show a year to year increase but the domestic demand deflator rose 0.1% in the second quarter, the third positive showing over the past seven years. Even so this hardly constitutes strong evidence that inflation is a near term threat.