Japan economy contracts as global slowdown hits exports

Honda factory in Japan Japanese car makers have seen their sales in China slide after the anti-Japan protests

Japan's economy contracted in the July to September quarter, as a global economic slowdown and anti-Japan protests in China hit exports, while domestic consumption remained subdued.

The economy contracted by 0.9% compared with the previous three months.

The contraction is the equivalent to an annualised drop in gross domestic product (GDP) of 3.5%.

The weak data is likely to put pressure on the government to boost stimulus measures to spur growth.

"There are risks from both domestic and external factors," said Tatsushi Shikano, senior economist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.

"As such, the Bank of Japan (BOJ) will stand ready to ease monetary policy again, and it would not surprise me if the BOJ eased again by the end of this year."

Heading for recession?

Japan's economy, the world's third-largest, has been trying to recover from last year's earthquake and tsunami, which caused widespread destruction in the country.

However, its recovery has been hampered by a combination of factors.

Start Quote

The decline in exports seems large. Consumption and capital expenditure were also weak, showing that both external and domestic demand are weak”

End Quote Yasuo Yamamoto Mizhuo Research Institute

A slowdown in key markets, such as the US and eurozone has hurt demand for its exports, one of the biggest drivers of Japanese growth.

Slowing growth and anti-Japan protests in China - Japan's biggest trading partner - have further impacted its export sector.

To add to its woes, the debt crisis in the eurozone and weak recovery in the US have seen many investors flock to safe-haven assets such as the yen, resulting in the Japanese currency strengthening against the US dollar and the euro.

The yen has risen 5% against the US dollar since March this year and 8.5% against the euro during that period.

That makes Japanese goods more expensive for American and European consumers, hurting the earnings of the country's exporters.

To make matters worse, attempts by policymakers to boost domestic demand have had little effect. Private consumption fell 0.5% in the July to September quarter, from the previous three months.

Analysts said that given these factors the economy was likely to shrink further in the current quarter and enter a technical recession.

"The decline in exports seems large. Consumption and capital expenditure were also weak, showing that both external and domestic demand are weak," said Yasuo Yamamoto, senior economist at Mizuho Research Institute in Tokyo.

"Economic data deteriorated sharply from September, and this means Japan is already in recession," he added.

Focus on yen

Faced with slowing external and domestic demand, Japan's central bank has taken various steps to try and spur growth.

Japanese Yen v US Dollar

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Earlier this month, the BOJ extended its asset purchase programme by 11 trillion yen ($138bn; £86bn). Under the programme, the central bank buys bonds to keep long-term borrowing costs down.

It also said that it will offer unlimited loans to banks to encourage lending in an effort to boost domestic consumption.

However, analysts said the measures were unlikely to have a major effect, not least because firms were holding back expansion plans in the wake of an uncertain economic environment.

"There is very little demand for credit. In fact Japanese firms are holding back on capital expenditure," Junko Nishioka, the chief economist of RBS Securities in Tokyo, told the BBC.

Ms Nishioka added that policymakers instead needed to focus on measures that will help weaken the yen, as the uncertain global economic environment was likely to see the Japanese currency, which is seen by some as a safe-haven asset in such times, remain strong.

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