Tokyo’s struggles with the pandemic have delayed its economic recovery. An extended state of emergency has weighed on demand for services and consumption. And it forced the Olympics to be held without spectators.
Fortunately, vaccination rates have been rising since the summer. An improvement in public health conditions, coupled with continued government support, should allow more domestic consumption in the coming quarters.
That said, economic growth in Japan will remain lackluster by global standards, averaging slightly below 2%. Japan’s structural woes will continue to hold the economy back. Subdued wage and employment growth will continue to put a lid on demand and inflation. Reflation is a common theme globally, but inflation continues to elude Japan, despite being a net importer of energy. Entering 2022, higher commodity prices will push inflation up, but it will continue to fall short of the central bank’s target.
"Even a global inflation wave won’t spread to deflation-prone Japan."
Headwinds for exports, an important source of revenue for the Japanese economy, have been mounting. With supply chain disruptions likely to last, industrial output will remain weak through the first half of 2022. Japan is well embedded in Asian supply chains, so any disruption in the neighborhood will disrupt Japan. We expect a gradual dissipation of supply bottlenecks and external demand to stabilize, which would deliver a much-needed impetus to Japan’s manufacturing exports.
However, an accelerated movement away from unfettered global commerce will not bode well for the Japanese economy. The fact that Tokyo will increasingly find itself caught in the middle of tensions between its two biggest export markets, the U.S. and China, could pose further problems.
Apart from technological innovation, Tokyo is also well-known for its stable political landscape. That image has suffered a minor setback as the office of the prime minister (PM) has had three occupants in just over a year’s time. However, a change in leadership won’t lead to a drastic adjustment of the current economic policy.
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The change in the ruling leadership is unlikely to cause the Bank of Japan (BoJ) to change policy, even though new PM Kishida does not appear keen on using monetary measures to promote reflation. Although the BoJ has been reducing the size of its asset purchases since March, its yield curve control policy will remain crucial for the government in maintaining flexible fiscal policy.
Despite pandemic-induced challenges, Japan is positioned for stronger growth next year. But inflation will continue to prove elusive. .
