Japan's economic growth sustains in July though price pressures and outlook worsen

Japan's private sector economy continued to expand at a strong pace at the start of the second half of 2023, according to flash PMI data, extending the growth streak that began since the start of the year. This was again supported by solid services activity growth though the pace of manufacturing output contraction also eased in July.

An elevated, but lower, degree of business confidence about the outlook suggests that the current expansion has further to run, albeit with the second quarter potentially representing a peak in the rate of growth.

Meanwhile, inflation remained elevated with price pressures exhibiting signs of gathering slight momentum, which places the focus on the upcoming Bank of Japan (BOJ) meeting for any possible tweaks to its current ultra-accommodative policy stance.

Japan's flash PMI indicates expansion continuing into July

The au Jibun Bank Flash Japan Composite PMI, compiled by S&P Global, remained unchanged at 52.1 in July. Sustaining above the 50.0 no-change mark for the seventh straight month, the latest flash PMI reading indicated that Japan's private sector continued to grow at the start of the second half of 2023. Despite growth momentum having eased to match the start of 2023 of late, it remained solid overall.

Growth was again exclusively driven by the service sector in July, as manufacturing output contracted for a second straight month. The latest composite output reading, covering both sectors, is broadly consistent with GDP growing at an annual rate of just under 2%.

Japan's economic growth still buoyed by services

July flash PMI data indicated that services activity continued to expand solidly in July and at a rate comparable to June. This extends the growth streak in this sector that began last September. Continued demand growth, notably due to increased tourism activity, supported the latest improvement in service sector conditions. That said, new business rose at the slowest pace in six months which, coupled with falling levels of outstanding work, foreshadows a possible further slowdown in services growth momentum in the coming months. Fortunately, the pace of outstanding business depletion is currently only marginal, though this remains a key indicator for further observation moving forward.

Meanwhile Japan's manufacturing sector output remained in contraction according to the latest July flash PMI data. Manufacturing production has now fallen in 11 of the past 12 months. Although the rate of contraction eased from June, a sharper fall in new orders for Japanese manufactured goods in the latest survey hints at the likelihood for prolonged weakness of the manufacturing sector. Likewise, work-in-hand at factories also declined at a marked pace at the start of the second half of 2023, further leading to the paring back of input acquisition. Goods producers attributed the latest downturn in orders to a lack of both domestic and foreign demand amid a slow pace of economic recovery and growing customer caution with respect to spending.

Although very slight indications of the sectoral gap narrowing had been witnessed in the latest survey, whereby services activity growth slowed marginally and manufacturing output contraction eased, the divergence between the two sectors nevertheless remained wide by historical standards. This split continues to outline the challenge for policymakers in managing their tools amid diverging performances.

Signs of intensifying input cost pressures

Adding to the diverging manufacturing and services performance in July was a difference in sector price inflation at the start of the second half of 2023. However, despite lower manufacturing input costs, overall price inflation accelerated in July.

A further easing of supply constraints, alongside the paring back of input buying in the manufacturing sector, led to factory input costs rising at the slowest rate since February 2021. That said, instances of higher energy and labour costs led to a faster pass-through of cost burdens in July, according to panellists, resulting in the first rise in selling price inflation among manufacturers since April.

Service providers meanwhile widely experienced higher input cost inflation, stemming principally from higher wages and fuel costs, leading to charges rising at a faster pace in the latest survey period.

In turn, overall input cost inflation consequently rose for the first time this year while output price inflation also climbed higher. Although the latest official June CPI continued to outline easing inflationary pressures in line with the PMI price trend, the latest PMI price data suggest that any meaningful fall past the 2% mark appears out of reach in the near term, foreshadowing sticker inflationary conditions in the upcoming couple of months.

Alongside sustained growth conditions, the latest indications therefore provide some support for the Bank of Japan to tweak their monetary policy operations even as they maintain their broad quantitative and qualitative monetary easing stance.

Optimism further moderates

Finally, companies further lowered their optimism regarding output in the next 12 months, according to the flash PMI indications. July's composite Future Output Index declined to the joint-lowest since January with sentiment across both the manufacturing and service sectors falling. Some firms grew more concerned about the economic outlook with heightened worries over the risk of recession according to anecdotal evidence.

The deterioration in business sentiment, alongside the softening of demand conditions in the latest survey, suggest that we may have seen a peak for the recent bout of economic expansion in Japan earlier in the second quarter. However, there is not sign yet of the upturn stalling.

Consequently, for the Japanese equity market, which finds a broad correlation with PMI data, a recent peak in growth conditions suggests that equity price gains may slow in the coming months. Yen movements will of course likewise play a role here, with both the US Fed and Bank of Japan expected influence currency movements in the very short term.

Jingyi Pan, Economics Associate Director, S&P Global Market Intelligence

jingyi.pan@spglobal.com

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Purchasing Managers' Index™ (PMI™) data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies, and are available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data are used by financial and corporate professionals to better understand where economies and markets are headed, and to uncover opportunities.

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