Economy in Brief: August 2023

Japan’s inflation in July continues at a pace in excess of the target sought by the Bank of Japan. However, inflation is not running wild; it's simply running hotter than the BOJ wants it to. Inflation had moved quite low in May with the headline of 0.1% and then picked up to 0.2% in June. The core rate, that had risen by 0.4% in May, slipped to a weaker rise of 0.1%. July shows the headline pace continues to accelerate with an increase of 0.4% and the core (all items excluding food & energy) logs the somewhat neutral 0.2% increase on the month.

July was an empty pinata for the hopeful On balance, the progression of inflation through July is disappointing. The monthly patterns are no longer encouraging and their progression of inflation from 12-months to 6-months to 3-months is neither disturbing nor encouraging and instead depicts an inflation rate that is wandering at a pace that's simply too high but without a clear trend. Headline inflation is up 3.2% over 12 months; that pace slips to 1.9% over 6 months but then moves back up to 2.7% over 3 months. The core pace that excludes food & energy shows the 2.6% increase over 12 months, rising to a 3.6% annual rate over 6 months, then settling back to a 2.8% annual rate over 3 months. While the core rate decelerates from 6-months to 3-months, the 3-months the rate is still above the 12-month pace which is not the signal that the Bank of Japan is looking for from the inflation rate.

Monthly inflation patterns If we rummage through the details of monthly inflation by industry, in July there are strong gains in reading and recreation as prices rose by 1.5%; also, for food and beverages as prices rose 0.8%; for clothing and personal items prices rose by 0.5%. In June there are not as many pressures present, but the largest month-to-month gain in these major categories is 0.3%. Categories with the max gain include food & beverages, clothing & personal items, and the miscellaneous category. Meanwhile, housing costs were flat in June as reading & recreational prices slipped by 0.2% month-to-month. In May when headline inflation was so low, four categories had increases of 0.4%; those were food & beverages, medical care, reading & recreation, as well as transportation & communication.

Longer inflation patterns Looking at these industry patterns, sequentially there's scant evidence of categories with inflation accelerating or decelerating for the most part inflation is just gyrating. Inflation changes look more chaotic or somewhat random. Over 3 months inflation decelerates for food & beverages, for educational costs, for medical care, for reading & recreation, and for transportation & communication. There are two decelerations in a row only for food & beverage prices that slip from an 8.7% gain over 12 months to an 8.6% gain annualized over 6 months, to a 6.2% annual rate over 3 months. That's the only category that shows clear directional progress; it's also the category with the hottest 3-month inflation growth rate.

Inflation steps into a new quarter With the July report, we're one month into a new quarter and looking at the rise in inflation in July relative to the previous quarterly average. The quarter-to-date headline inflation at 3.3% with core inflation running at a 2.4% annual rate, finds inflation is excessive for food & beverages at 7% in the quarter, clothing and personal items inflation is at 4.4%, reading & recreation prices are up at a 9.4% annual rate, while transportation & communication prices are up to a 3.6% annual rate. However, housing prices, education, medical care, and miscellaneous items are all running inflation rates in the one to 1 ½ percent range, quite subdued.

Japan's trade trends continue to show deterioration. The early press reports on Japan's trade picture have focused on weak Japanese exports and how this weakness is going to constrain domestic growth. But such analysis dwells on only half of the picture in trade.

International trade and the theory of relativity The international contribution to GDP comes from the current account and with some small adjustments it becomes something called GDP net exports. This measure is the difference between exports and imports- as always expressed in real terms since we are always interested in real GDP growth. When exports exceed imports, there's a boost to GDP from trade; if imports exceed exports, there's a subtraction from GDP. It is not just exports that matter, or just imports; it’s one flow relative to the other. They both matter. Like any other flow quarter-to-quarter, the impact of the flow, in this case the net flow, on GDP, depends on the change in this balance or net. The second quarter in Japan saw that trade made an enormous impact on GDP; in fact, trade accounted for all the growth in GDP in the second quarter by itself. As we look at Japanese trade trends, July is starting the third quarter with the same forces as those in gear during the second quarter.

Strength though weakness… Seasonally adjusted exports were up by 0.5% over 12 months and that's a weak showing. However, imports are falling by 14.7%. That means imports are weaker than exports and it implies that the contribution from imports to GDP is going to be larger than the contribution of exports to GDP. Since imports are a subtraction from GDP, the weaker import number implies a positive kick to GDP, even as exports slow. Of course, we're very early in the third quarter and we're going to be concerned with the year-over-year change but what happens in the third quarter compared to the second quarter. In July itself, exports and imports each rose by 2% marking a sort of standoff in terms of their impact on GDP. But I simply do not see the rationale for being worried about Japanese growth because Japanese exports are weak. Global trade is weak. It looks like Japan is having weaker imports than exports which should be a positive development for Japan's GDP accounts.

Foreign exchange Japan's exchange rate against the dollar has deteriorated only slightly; based on year-over-year changes it's only 3.1% weaker. The real broad exchange rate that is trade weighted and price adjusted yen against all of Japan's trading partners is weaker by only 1.7% over the past 12 months. There is some evidence of growing weakness in the exchange grade from 12-months to 6-months to 3-months.

Export and import yen prices and volumes Export and import prices show export prices down 0.2% over 12 months. Import prices are down by 14.2% over 12 months. This means a lot of the weakness in imports has come on the price side rather than on the volume side. However, the volume statistics echo what we see in the nominal data as well with real exports growing by 0.8% over 12 months and real imports falling by 0.5%. Over 3 months exports fell at a 0.3% annual rate in real terms while imports fell at a 5.1% annual rate in real terms.