Germany Overtakes Japan to Become the Third-Largest Economy as Japan Enters A Recession

Japan’s economy has recently fallen into a recession, resulting in the country losing its position as the world’s third-largest economy. The reason for this unexpected recession is weak domestic demand, which has put pressure on Japan’s economy. As a result, the country has experienced a second consecutive quarter of contraction, which meets the definition of a technical recession. This has raised uncertainties about the central bank’s plans to exit its ultra-easy policy sometime this year.

What caused Japan’s recession?

According to the data, private consumption, which accounts for more than half of Japan’s economic activity, fell 0.2 percent, compared to a 0.1 percent increase predicted by economists. This is attributed to households tightening their budgets in response to rising living costs. Household spending fell 2.5 percent in December compared to a year ago. Capital expenditure, another key private-sector growth engine, fell 0.1 percent, compared to expectations of a 0.3 percent increase. External demand, or exports minus imports, contributed 0.2 percentage points to GDP, with exports up 2.6 percent from the previous quarter.

In US dollar terms, Japan’s economy fell to fourth place in the world last year as households and businesses cut spending for the third quarter in a row. In October last year, the International Monetary Fund (IMF) predicted that Germany would overtake Japan as the world’s third-largest economy measured in US dollars. However, the IMF will only declare a change in ranking after both countries have published their final versions of economic growth data. It first published data comparing economies in 1980.

Japan’s GDP fell by a worse-than-expected 0.4 percent in the final three months of 2023 compared to the same period a year ago. It came after the country’s economy contracted by 3.3% in the preceding quarter.

What will happen next?

The weak economic data may call into question the Bank of Japan’s (BOJ) forecast that rising wages will support consumption and justify the phaseout of its massive monetary stimulus. The BOJ has been working to eliminate negative interest rates by April and overhaul other aspects of its ultra-loose monetary framework. However, given the lingering risks, it is likely that any subsequent policy tightening will be gradual.

Though BOJ officials have not stated as to when they could expect to end negative rates, several market players believe it will happen in March or April. According to some analysts, Japan’s tight labour market and robust corporate spending plans keep the prospect of an early exit from the ultra-loose policy alive.

“The BOJ could be forced to sharply lower its rosy GDP forecasts” for 2023 and 2024, said Takuji Aida, chief economist at Credit Agricole. “There’s a risk the economy will contract again in the January-March quarter due to slowing global growth, weak domestic demand, and the impact of the New Year quake in western Japan.”

Marcel Thieliant, the head of Asia-Pacific at Capital Economics, stated, “While the second consecutive contraction in GDP in Q4 suggests that Japan’s economy has entered a recession, business surveys and the labour market tell a different storey. In any case, growth is expected to be slow this year as household savings rates fall.”

Following the data’s release, the yen did not change significantly. The Japanese yen last traded at 150.42 per dollar, close to a three-month low set earlier this week. The Nikkei rose 1%, reversing some of its losses from the previous session, possibly on expectations that the BOJ will continue with its massive easing programme for longer than expected.

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