The Outlook for the Japanese Economy

Transcription

1 June 8, 21 (Original Japanese version released May 31, 21) The Outlook for the Japanese Economy Economic Research Office The Bank of Tokyo-Mitsubishi UFJ, Ltd. Financial Markets to Remain Vulnerable Even While Real Economic Recovery Continues 1.Current Economic Conditions Fourth straight quarter of positive GDP growth in Jan-Mar Japan s economy continues on its recovery trajectory on increased exports, especially to Asia, and government stimulus measures. Real GDP grew an annualized 4.9% QoQ in Jan-Mar, the fourth straight quarter of positive growth (Figure 1). Net exports (exports minus imports) once again made a strong +2.7ppt contribution, while domestic private demand, including consumption and capital expenditures, also propelled growth with a +2.1ppt contribution. Japan s annualized growth rate over the past four quarters has averaged 4.2% QoQ, well exceeding the potential growth rate of.5%-.8%; the economy is recovering at a faster-than-anticipated pace on external demand and government stimulus efforts. However, Japan is still merely within rebound range following the steep plunge caused by the collapse of Lehman Brothers, and domestic demand capital expenditures and employment has only started to improve gradually toward a self-sustaining recovery. Table 1 : Main Economic Indicators (percent changes from previous quarter or month) 29/Jul-Sep Oct-Dec 21/Jan-Mar 21 / Jan Feb Mar Apr Nominal GDP Growth Rate (annualized; q/q) Real GDP Growth Rate (annualized; q/q) Index of Business Conditions (coincident index) Index of Business Conditions (leading index) Industrial Production Machinery Orders (private, excl. shipping and electric power) Shipments of Capital Goods (excl. transport equipment) Number of Employees (nonagricultual industries) Nominal Cash Earnings (5 or more workers) Unemployment Rate (SA,%) Aggregated Consumption Index (SA) Consumer Confidence (general households, q/q) Exports Volume Imports Volume Consumer Prices (excl. fresh food) Notes: 1. Results for the number of employees, total cash earnings and domestic corporate goods prices are % changes from previous year. 2. Quarterly data for Index of business conditions are results for the end of each quarter. Sources: Compiled by the Research Office, Bank of Tokyo-Mitsubishi UFJ based on Cabinet Office "National Accounts", "Orders Received for Machinery ", "Consumer Confidence Survey ";METI "Industrial Production"; MOF "Trade Statistics"; Ministry of Health, Labour and Welfare "Monthly Labor Statistics", Ministry of Internal Affairs and Comunications "Consumer Price Index", "Labour Force Survey" 1

2 Economic recovery broadening, through slowly 2.Outlook Summary Despite considerable unclarity, various measures likely to limit possibility of another financial crisis Japan s strong GDP growth in Jan-Mar should probably be somewhat discounted because of the impact of one-off factors like a surge in demand for thin screen TV s. Even so, other economic indicators reflect improving conditions. Employment and wages started to rise in March, while capacity utilization rates indicated a turnaround in production, rising to levels early in the previous recovery cycle. The economic recovery continues to broaden, however slowly. While the real economies both in Japan and abroad are stabilizing, uncertainty regarding the future is building. Concerns about the sovereign credibility of the PIIGS countries and tighter financial restrictions in US and Europe have shaken financial markets. There is also fear that falling stock prices and yen appreciation may worsen sentiment and corporate profits. But for now, the worst has been averted due to EUR11 billion in support to Greece, a EUR75 billion emergency package from the EU and IMF, and major central banks resumption of US dollar funds-supplying operations. Though severe fiscal restraint may suppress European economies, Asian economies to which over half of Japanese exports are bound will likely maintain steady growth. Exports are likely to continue leading the Japanese economic recovery. The effects of the government s stimulus packages will fade, but it is unlikely that the economy will lose momentum this year because surges in demand are expected before the various consumption incentive packages end. Export- and policy effect-driven economic recovery expected to continue The Japanese economy is expected to stay on a moderate recovery path due to export growth and policy effects, though the pace of recovery will slow from the current fast clip. In FY11, though the economic recovery is expected to spread to capital expenditures, employment and household income, the backlash of policy effects ending will result in slower growth. We expect year-on-year GDP growth of 2.3% in FY1 and 1.5% in FY11 (Figure1). 2

3 (qoq saar,%) Figure1:Real GDP Growth Rate Private Consumption Housing Investment Business-fixed Investment Net Exports Inventory Investment Government Expenditures GDP Outlook (year) Source: Compiled by BTMU Economic Research Office, based on Cabinet Office "National Accounting" European sovereign debt issue to remain as the biggest risk factor But sovereign debt credibility concerns for European countries will persist. If any incidents such as failed fiscal restructuring in the PIIGS countries trigger financial market nervousness, the possibility that falling stock prices and yen appreciation could cause the economy to plunge cannot be ruled out. For now, we think it is more likely that the economy will remain on a recovery course; however, bear in mind that current conditions do not allow for optimism. <Detail> (1)Corporate Sector 1 Exports Exports continue Exports are steadily improving. Real exports (customs-cleared) rose +9.% strong, led by QoQ in Jan-Mar, a fourth consecutive quarter of solid gains (Figure 2). shipments to Asia Shipments to Asian countries, mainly China, continued to pull exports overall. By export items, general machinery shipments continued to recover, following electronic machinery and raw material-related goods, which started to recover first. Capital expenditures have started to rise in Asia, contributing to the widening range of improving export items. 3

4 (QoQ, %) 15 Figure 2:Real Exports (QoQ, %) 2 Figure 3: Real Exports to Asia Others EU Asia(ex. China) China U.S. World Note: Real exports=export volume Export price(by country) Source: Compiled by BTMU Economic Research Office based on MOF Trade Statistics Other Transport machinery General machinery Raw materials-related Electronics related Total Note: Real exports = Export value Export value Electronics-related = Electronic equipment plus precision instruments Raw materials-related = Textiles, non-metalliic materials, chemicals, metals and metal products. Source: Compiled by BTMU Economic Research Office from MoF Trade Statistics. Exports to continue recovering, though more slowly The pace of future export growth will slow as the reactionary jumps end. However, overseas economies are likely to continue their solid recoveries, though the speed will slow somewhat in Asia, primarily China. We thus expect that exports will continue to recover (Figure 4). We fear that the financial instability triggered by Greek problem will weigh on European economies. However, the share of Japanese exports destined to the EU is only about 1%; shipments to Asia that account for the bulk of Japanese exports will remain firm, so the risk of dramatic drop in exports is limited (Figure 5) Figure 4: GDP Growth Rate for Japan's Main Export (yoy, %) U.S. Europe China Asia(ex. China) World Outlook North America Figure 5: Export Share by Destination Region Africa Central, South America Mid-East Other EU (excl PIGS) 11% PIGS 1% (year) Note: GDP growth rate for Japan's main export destinations is the weighted average of the GDP growth rates for Japan's main export destinations: U.S., Eurozone, U.K., China, NIEs, ASEAN4 and India, based on the the value of Japan's exports to that country. Source: Compiled by BTMU Economic Research Office, based on Cabinet Office "National Accounting"; Ministry of Finance, "Trade Statistics", etc. Oceania Asia 54% Note: FY9, in terms of export value. Source: Compiled by BTMU Economic Research Office from MoF Trade Statistics. Production likely to continue increasing, though more gradually Industrial production is rising as exports recover and private consumptions of durable goods such as cars and home electronics improve (Figure 6). The upward trend is expected to be sustained due to the export recovery; however, since the pace of recovery will be slow and the durable goods effect will drop off, production growth will be only gradual. 4

5 (Year 25 = 1) 12 Figure 6 : Industrial Production and Exports Industrial Production Exports <right scale> Note: May and June production forecast indexes extrapolated from April results. Source: Compiled by BTMU Economic Research Office from METI Industrial Activity Indexes, Bank of Japan Real Exports. 2 Year 2 Capital Expenditures Gradual Capital expenditures rose for the second straight quarter, by an annualized improvement in +4.2% QoQ in Jan-Mar. Capacity utilization rates have risen to the level at the capital start of the last economic recovery as production began to pick up (Figure 7); expenditures to capital expenditures are thus expected to slowly start to rise. Machinery orders, a continue leading indicator of capital expenditures, are gradually beginning to rise from their lows (Figure 8). Manufacturing had started to improve first as exports and production recover, while non-manufacturing appears to be hitting a bottom. This suggests that increased capital expenditures are gradually starting to spread to industries overall. (Seasonally adjusted, %) Figure 7 : Capacity Utilization Ratio Notes : April capacity utilization ratio is actual Industrial Production, data; data for May and June have been estimated using forecast data. Based on assumption that production capacity remains flat. Source: Compiled by BTMU Economic Research Office based on METI Industrial Production and Cabinet Office materials. Figure 8: Machinery Orders (Seasonally adjusted, JPY bn) 1,3 1,2 1,1 1, Private demand (excl shipbuilding, electricity generation) 3 Same, 3-month moving avg 2 Manufacturers 1 Non-manufacturers (excl shipbuilding, electricity generation) Source: Compiled by BTMU Economic Research Office from Cabinet Office Machinery Orders. 5

6 Weak euro pressing on corporate revenue, weighing on capital expenditures We project that capital expenditures will continue to recover as the economy picks up but remain at low levels even as corporate earnings improve. A strong sense of excess capacity still persists, and we thus expect that it will be some time before a true recovery takes hold. In particular, the rapidly surging yen and plunging euro have emerged as causes for concern in regard to corporate profits (Figure 9). Though the share of euro trade is not particularly high compared to dollar trade, the yen has strengthened by approximately 1% since May, and the impact, though limited to some sectors, has not been insignificant on corporate profits. This could weigh on capital expenditures (Figure 1) (EUR/JPY) Figure 9: JPY Exchange Rates (USD/JPY) Figure 1: Trade Transactions by Currency Share Export Transactions EUR 7% Other 4% Import Transactions EUR 4% Other 2% EUR USD (right axis) JPY 39% USD 49% JPY 24% USD 7% /1 1/2 1/3 1/4 1/5 (Yr/Mo) Note: As of H2 29. Source: Compiled by BTMU Economic Research Office from Bloomberg data. Source: Compiled by BTMU Economic Research Office from MoF Trade Statistics. (2)Household Sector 1 Employment and Wages Employment and Employment and wage conditions continue to improve, though only wage conditions to gradually. Employee numbers and the jobs-to-applicant ratio are rising, and continue to slowly wages (total cash earnings) on March started to increase for the first time in 22 improve months (Figure11, 12). Figure 11: Worker Numbers and Job-Offers-to-Seekers Ratio 5,6 5,55 5,5 5,45 5,4 5,35 5,3 (Seasonally adjusted, ', persons) Number of workers 3-month moving avg Job-offers-to-seekers ratio (right axis) (Seasonally adjusted, multiple) Figure12: Total Cash Earnings Breakdown (QoQ contribution, %) Special earnings -5 Non-scheduled earnings -6 Scheduled earnings -7 Total cash earnings 5, Source: Compiled by BTMU Economic Research Office from MIC, MHLW materials Note: Establishments with 5 or more employees Source: Compiled by BTMU Economic Research Office based on MHLW Monthly Labour Survey. 6

7 We believe that employment conditions will continue to improve mainly in the service sector, especially in the medical and welfare sector. The manufacturing sector will also likely improve because of the production recovery. But there is still a strong sense of employment overcapacity, so we think the tempo of improvement will remain gradual. We forecast that wages will recover slowly. Due to stronger corporate profits, summer bonuses (special wages) in 21 have risen by 2.% YoY, while overtime payments (additional wages) have been on an upward trend because of the production recovery (Figure 13). While fixed wages have fallen because of the negative factor of still-loose labor demand and supply, wages overall are trending upward. We believe that real wages are still rising year-on-year because of improving employment and wage conditions and falling prices (Figure 14). (YoY, % change) Figure 13: Ordinary Profits and Bonuses Figure 14: Employee Compensation 1 (YoY, % change) 15 4 (YoY, %) Ordinary Profits Bonuses (right axis) Projection Note: Ordinary profit estimates for companies of all sizes, six months in future; FY1 projection as of March Tankan Survey. Bonuses for companies with 5+ employees, based on MHLW data. Source: Compiled by BTMU Economic Research Office from BoJ Tankan Survey, MHLW Monthly Labor Survey Private consumption deflator (inverse) Number of employees Per-capita cash earnings Real compensation of employees Note: Employee real compensation =Per-capita cash earnings Number of employees Source: Compiled by BTMU Economic Research Office from MIAC, MHLW, Cabinet Office materials. Outlook 2 Private Consumption Upward push from Real private consumption (in GDP data) rose an annualized +1.3% QoQ in durable goods Jan-Mar, the fourth straight quarter of positive growth (Figure 15). Though the purchases waning positive contribution from durable goods remained strong, the rate of rise slowed somewhat from the previous three quarters; the ecocar subsidies and ecopoint system are bolstering consumption less than before. 7

8 8 (QoQ, annualized %) Figure 15: Real Private Consumption Direct overseas purchase by resident households -4 Services Non-durable goods Semidurable goods -6 Durable goods Real Private Consumption (year) Note: Figures for real final consumption expenditure of households do not correspond to the total of contributions of all the components in the chain-linking method. Source: Compiled by BTMU Economic Research Office based on Cabinet Office, National Accounting. Slim hopes that automobile sales will support consumption Thin-screen TV s expected to continue to rise as economy improves, but will gradually flatten Automobile sales have hit the ceiling since the end of last year at about 3,-35, units per month. We think that sales are unlikely to drop significantly as employment and wage conditions keep improving, but we do not expect auto sales to further boost consumption, aside from the impact from a jump in buying before the ecocar subsidies wind down at the end of September (Figure 16). Thin-screen TV sales surged in March before ecopoint system eligibility rules were changed the following month, and April sales reflected a reactionary drop. Approximately 6-65% of households now own a thin-screen TV following the surge in sales 1 (according to BTMU estimates), but we think there is still some room for further increase as these new models replace CRT TV s (Figure 17). However, as noted before, because the number of eligible TV models for the ecopoint system was cut beginning in April, thin-screen TV sales will likely grow only slightly. Also, the rise in thin-screen TV sales is due partly to the shift to terrestrial digital broadcasting, but since 83.8% of households were prepared for terrestrial digital broadcasting as of the end of March, it appears likely that thin-screen TV demand due to the shift in broadcasting systems will shrink. 1 Of 47.8 million households, 63.4% owned thin-screen TV s as of March 15. The total of half of March (2.21 million) and all April (1.38 million) shipments was 2.49 million, and assuming that 51.5% of these purchases (the share of first sets among purchases made between March 15, 29, and March 15, 21) were first purchases, we estimate that the thin-screen TV penetration rate will be 66.1% as of the end of April 21. 8

9 (1, units) Figure 16: Vehicles and TV Sales Vehicles Television (right scale) (1, units) (%) Figure 17: Thin-Screen TV, Digital Terrestrial Receptivity Penetration Rates Thin-screen tv's Digital terrestrial receptivity BTMU projection: 66.1% as of end-april Notes: Adjusted for seasonality by BTMU Economic Research Office. Vehicles include mini-vehicles. Sources: Compiled by BTMU Economic Research Office based on Japan Automobile Manufacturers Association New Registrations, Mini-Vehicles Sales and Japan Electronics and Information Technology Industries Association Domestic Shipments of Major Consumer Electronic Equipment. Note: All households (general and single-person). Total of LCD, plasma screen types based on survey conducted March 15 annually. Source: Compiled by BTMU Economic Research Office based on Japan Electronics and Information Technology Industries Association, Cabinet Office Consumer Sentiment Survey, MIC Digital Terrestrial TV Penetration Rate Survey. Solid consumption anticipated for 21 Although the boost to consumption from automobile and TV sales will wane, we predict that the consumption recovery will gradually broaden to other goods and services as employment and wage conditions the basis of consumption improve. We anticipate a.4ppt upward contribution to private consumption from childcare allowance payments (Figure 18) that will boost household incomes starting in June. FY1 private consumption is expected to remain solid as the ecocar subsidy program and ecopoint system are scheduled to end at the end of September and December, respectively, and are expected to trigger buying surges. This is also likely to continue to support private consumption in 21 (Figure 19). Consumption will likely drop in early 211 in reaction to the buying surge before the stimulus programs end, but we think that improving employment and wage conditions will ease any reactionary drop and consumption will avoid a sharp decline. Figure 18: Impact on Household Income from Upcoming System Changes (YoY change, JPY 1mn) Payment of childcare allowance Cancelling childcare allowance Abolishing, reducing income tax exemptions Change in household income 1 11 (FY) Note: Assuming that income tax exemptions are abolished or reduced starting in January 211 and childcare allowances are paid (JPY26,/month) starting in FY11. Source: Compiled by BTMU Economic Research Office from MoF materials, DPJ Manifesto, and various news sources (qoq, ann. %) Figure 19: Real Private Consumption Outlook (year) (Source) Compiled by BTMU Economic Research Office based on Cabinet Office, "National Accounting." 9

10 3 Residential Investment Residential Residential investment in Jan-Mar grew positively for the first time in five investment starts quarters, at an annualized rate of +1.1% QoQ. Better household sentiment for to improve, rising home purchases as well as a gradual recovery in employment and income for first time in five conditions contributed to the shift. Low interest rates, preferential tax treatments, quarters and the housing eco-point system have also been behind the recovery (Figure 2). By type of usage, owner-occupant and detached home starts have continued to recover, while condominium starts have remained at bottom levels (Figure 21). Although the condominium market has been strong in metropolitan areas, prices and inventory are still at high levels, and this will continue to pull down new housing starts for a while (Figure 22). Figure 2:New Housing Stars and Residential Purchase Sentiment (Seasonally-adjusted annualized, ', units) /6 111pt 21/4 11pt (pt) New housing starts 2 Real Estate Purchase Sentiment Index (right axis) ( 年 ) Note: New housing starts seasonally adjusted by BTMU. Source: Compiled by BTMU Economic Research Office from MLIT Housing Starts and Nippon Research Institute Consumer Sentiment Index (Seasonally-adjusted annualized, ',units) Figure 21: New Housing Starts by Owner-Occupant Relation Owner-occupied + Detached homes Rent homes Condominiums Note: Owned homes + Subdivided detached homes, Condominiums and Rent homes seasonally adjusted by BTMU. Source: Compiled by BTMU Economic Research Office from MLIT Housing Starts. Residential investment to keep improving, though more slowly Residential investment is expected to keep slowly recovering with continued improvement in employment and wage conditions and further spread of home purchase incentives (Figure 23). However, the recovery in new housing starts will remain slow due to the prolonged inventory adjustment and high condominium prices. There may also be a backlash from ending the eco-point system in December and reduced favorable tax treatment next year. 1

11 (2avg=1) 25 2 Figure22:Codominium Market Trend Completed inventory units (left axis) Units sold (left axis) Sales price (right axis) (', JPY) (QoQ annualized, %) (QoQ annualized, %) GDP Residential Investment (left axis) Housing Starts (right axis) 5 Figure23:Residential Investment and Housing Forecast Note: Three-month average data. Sales prices are weighted averages of new condominium prices in Kanto, Kinki region by units sold in respective regions. Simple totals of Kanto, Kinki region completed inventories, units sold. Source: Compiled by BTMU Economic Research Office from Haseko Corporation CRI Source: Compiled by BTMU Economic Research Office from the Cabinet Office "National Accounting" and MILT, "Statistics on Building Construction Starts" (3)Prices Downward price pressures from ex-energy goods, services to persist Consumer prices continue to decline. The March Consumer Price Index (core CPI, excluding fresh foods) stood at -1.2% YoY, the same pace as in February (Figure 24). The negative contribution of energy prices has worn off; on the other hand, other goods and services continue to exert downward pressure on the CPI. That said, deflationary pressures are weakening because the supply-demand gap is shrinking as the economic recovers (Figure 25). 3 (yoy, %) Figure24:Consumer Price Index -1 Figure 25: The Output Gap ([Excessive] minus [Insufficient], Ppt) Energy Foodstuffs (excl fresh foods) High school tuition -2 Other goods & services (excl high school tuition) CPI general, excluding fresh food Note: Energy="Electricity", "Gas, manufactured & piped", (year) "Liquefied propane", "Kerosene", "Gasoline " Source: Compiled by BTMU Economic Research Office based on MIC, "Consumer Price Index." Note: Output gap isaverage of Production Capacity DI and Employment Conditions DI weighted by Labor, Capital Distribution Rate (average 2-21). June 21 value is projection. Source: Compiled by BTMU Economic Research Office from BoJ Tankan survey. Upward price pressures building from upstream sources On the other hand, inflation pressures from rising commodity prices are growing due to the backdrop of the economic recovery, especially in emerging countries (Figure 26). Raw material prices in the corporate goods prices index have started to rise by double digits in year-on-year terms. Further, intermediary good prices are at year-ago levels because of a negative influence from sharply-rising resource prices (Figure 27). 11

12 (Base year 25 = 1) Figure 26: CRB Index Note : CRB Index is calculated by the future dealing price of 19 main items which(year) represent international commodities such as oil, natural gas, gold, bronze, soy beans, wheat and sugar. Source: Compiled by BTMU Economic Research Office from Bloomberg data. (yoy %) Figure 27: Corporate Goods Price Index raw materials intermediate goods(right scale) final goods(right scale) (yoy %) Source: Compiled by BTMU Economic Research Office based on BoJ, (year) "Corporate Goods Price Index" Core CPI projected In the future, changes in measuring methods are expected to cause the core to turn positive in CPI to post big fluctuations regardless of consumer price trends based on H1 211 supply-demand gap. Core CPI will be pushed down -.4ppt in FY1 and rise +.1ppt in FY11 due to the waiving of high school tuitions from April and a cigarette tax hike from October (Figure 28). While deflationary pressures on consumer prices will weaken, we expected the core CPI to continue to decline because of the system changes noted above, and then rise in the first half of FY1 (Figure 29). Figure 28: Effect on Core CPI by System Change (YoY contribution, %pt) (YoY, %) Figure 29:Consumer Price Index.2.1. FY211:+.1%pt Outlook FY21:.4%pt Cigarette tax hike Waiving of high school tuitions Effect by system change -.6 1/4 1/7 1/1 11/1 11/4 11/7 11/1 (Yr/Mo) Source: Compiled by BTMU Economic Research Office based on MIC Consumer Price Index, MoF FY11 Large Package of Tax Revisions, and various new sources Energy Food,excluding fresh food Other goods and services CPI general, excluding fresh food Note: Energy = Electricity, gas (manufactured & piped), liquefied propane, kerosene, and gasoline. Includes waiving of high school tuitions from April 21 and increase in cigarette taxes in October 21. Source: Compiled by BTMU Economic Research Office based on MIC Consumer Price Index. 3. Finance (1)Monetary Policy, Short-Term Interest Rates BoJ to maintain The Bank of Japan has been maintaining an ultra-low policy rate of.1% in monetary easing an effort to lift the economy out of deflation, while also aggressively supplying funds through expanded new operations (supplying funds at a fixed interest rate, 12

13 (trillion yen) also considered quantitative easing in a broad sense) introduced at the end of 29. Its current account balance has also been rising (Figure 3). The BoJ further announced plans to supply funds to bolster the foundation for growth for Japan s economy following the May 2-21 Monetary Policy Board meeting (Table 2). The BoJ considers a declining potential growth rate the fundamental cause of deflation, and began to consider these measures after determining that supporting private sector efforts to bolster the potential growth rate by supplying funds was critical. However, more precise guidelines regarding the amount of lending and target sectors will probably be needed before the effectiveness of these measures can be gauged. Figure 3: Current Deposit Balance of the Bank of Japan Table 2: Funds Supplying Operations to Bolster Growth Base Outline proposal Funds supplying method Loan term Interest rate Loan amount for each borrower Loan total amount Loan disbursement terms, etc Funds supplying against pooled collateral In principle 1 year, can be refinanced Uncollateralized overnight call rate at time of loan Based on each target financial institution's growth base-boosting financing/investment results To be determined at start of operations (year) Source: Compiled by BTMU Economic Research Office based on BOJ "Bank of Japan Accounts" BoJ Governor Shirakawa's press conference explanation: Financing, investment terms to be negotiated with targeted financial institutions In line with growth strategies outlined by government and various economic bodies Not to be a permanent policy Will not intervene in specific resource allocation for individual industries or companies Source: Compiled by BTMU Economic Research Office from BoJ materials. Policy rate likely to remain intact in FY1 In regard to monetary policy going forward, we think it is unlikely the BoJ will move closer to ending its low interest rate as downside risk to the economy both in Japan and abroad remain strongly rooted due to the problems in Greece. The BoJ will probably maintain the current policy rate through the remainder of FY1 as prices continue to fall. Short-term interest rates continue to decline because of the BoJ s monetary easing. Euroyen 3-month TIBOR has fallen to approximately.38%, the lowest level since 26, and we project that it will continue to decline as the BoJ maintains monetary easing. (2)Long-Term Interest Rates, Fiscal Policy Benchmark JGB Aversion to risk is building around the world due to sovereign debt problems yield drops to triggered by the Greek fiscal crisis and tightened financial regulations in Europe approximately and the US. This has been putting downward pressure on the benchmark JGB 1.2% yield as funds pour into safer assets like sovereign debt. The yield on newly-issued 1-year JGBs has fallen to around 1.2%, nearly a 2bp decline 13

14 from the recent peak in April (1.45%, Figure 31). The benchmark JGB yield is very likely to remain low for the time being on aversion to risk (%) Figure31:Newly-issued ten-year government bond yields (year) Source: Compiled by BTMU Economic Research Office based on Bloomberg data. Growing risk of benchmark JGB yield rise over medium to long term Unclear whether the administration can draft an effective fiscal restructuring policy (3)Exchange Rates Yen continues to rise on risk aversion That said, there is growing risk that the benchmark JGB yield will rise (as JGB prices drop) over the medium to long term because of Japan s deteriorating fiscal conditions. This is because pension and medical treatment costs will likely rise as Japan s population ages, and retirees are expected to tap into their savings more, thus depleting one of the main sources for buying JGBs. The administration plans to draft its Fiscal Management Strategy (outlining its fiscal restructuring plans) and a Medium-Term Fiscal Framework (revenue and expenditure plans for three years through FY13) in June. That said, there is considerable uncertainty regarding whether the administration can present a realistic roadmap. Unless the ruling Democratic Party of Japan drastically re-assesses the manifesto it campaigned on in last year s Lower House elections, expenditures will continue to balloon while the quest for additional funds through efforts like public project reviews is not yielding expected results. The JPY rose on global aversion to risk, standing at approximately USD/JPY9 since late March (Figure 32). Japan faces dire fiscal conditions, but the country remains a net creditor country and thus the JPY remains a sought-after currency because of its relatively safety. 14

15 JPY to start to weaken this summer due to growing expectations of higher US yields We project that such aversion to risk will continue for some time, and the JPY may further strengthen in the near term. The US Federal Reserve Bank is expected to gradually hammer out its monetary easing exit policy from autumn, and speculation will grow regarding rising interest rates in the US. This will likely cause the yen to start to weaken. Limited impact from RMB revaluation expected The impact on forex markets from a revaluation of the RMB should also be addressed, but we feel any impact will be limited. When the RMB was revalued in 25, the JPY as a fellow Asian currency similarly rose in value. Though at one point the JPY rose by four yen against the USD, the JPY trended weaker over the longer term (Figure 33). This was primarily because the FRB was implementing successive rate hikes at the time and the interest rate spread was widening. This time also, the FRB is inching toward ending its low interest rate policy, so we think any associated rise in the JPY from a RMB revaluation will be temporary. Also, Chinese officials are wary of any impact on their own economy from a currency revaluation and will probably thus not revalue their currency significantly. These factors will likely mean that any impact on the JPY market will be limited. (JPY/USD) Figure32:Dollar-yen exchange rate (USD/JPY) 125 JPY Figure 33: RMB Exchange Rates RMB (right axis) (USD/RMB) (year) Source: Compiled by BTMU Economic Research Office based on Bloomberg data 5/1 5/3 5/5 5/7 5/9 5/11 (Yr/Mo) Source: Compiled by BTMU Economic Research Office from Bloomberg data. (Toshiki Iwaoka, Shin Takayama, Shinji Ishimaru, Mikiko Nishimura) 15

16 For further details, please contact the Economic Research Office (Chief Manager Sakuma) Tel: Directed by Toshiki Iwaoka Written by Shin Takayama (Public Sector and Financial Market) Written by Shinji Ishimaru (Corporate Sector, Employment and Wages, Private Consumption, and Prices) Written by Mikiko Nishimura (Residential Investment) This report is intended for information purposes only and shall not be construed as solicitation to take any action such as purchasing/selling/investing financial market products. In taking any action, each reader is requested to act on the basis of his or her own judgment. This report is based on information believed to be reliable, but we do not guarantee its accuracy. The contents of the report may be revised without advance notice. Also, this report is a literary work protected by the copyright act. No part of this report may be reproduced in any form without express statement of its source. This report is also available for viewing online at 16

17 Outlook for the Japanese Economy Economic Research Office Forecast Bank of Tokyo-Mitsubishi UFJ ( %, billion yen ) Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q ( percentage change from the previous period at seasonally-adjusted annual rates ) FY29 FY21 FY211 Nominal GDP Real GDP GDP Deflator Private consumption Housing investment Private business fixed investment Business inventories (billion yen) 1, , ,527 Government expenditures Public investment Exports Imports (<> contribution of overseas demand) <.1> <1.6> <.4> Final Demand ( Private Demand) Industrial Production Index (MOM,%) Domestic Corporate Goods Price Index (YOY,%) (3.6) (4.9) (7.3) (2.6) ( 1.9) ( 5.5) ( 8.2) ( 5.2) ( 1.7) (.2) (.2) (1.6) (1.9) ( 5.2) (.8) (1.3) Consumer Price Index (excl. fresh food YOY, %) (1.) (1.5) (2.3) (1.) (.1) ( 1.) ( 2.3) ( 1.8) ( 1.2) ( 1.4) ( 1.1) (.6) (.5) ( 1.6) (.9) (.3) Trade Balance (billion yen) 2,679 1, ,42 1,352 1,96 2,379 1,79 1,469 1,768 1,753 6,678 6,699 6,16 Current Balance (billion yen) 6,35 4,429 3,715 2,371 2,181 3,516 3,626 3,966 4,55 3,924 3,741 4,98 4,14 15,658 15,92 16,279 Uncollateralized overnight call rate Euro-Yen TIBOR (3-mo.) Newly Issued 1-Year Government Bonds Yield Exchange Rate ( Yen / U.S.$ ) Note: Uncollateralized overnight call rate is end-of-period rate. Euro-Yen TIBOR (3-mo.), newly issued 1-year government bonds yield, and exchange rate (Yen/U.S.$) are period average.domestic Corporate Goods Price and Consumer prices reflect 25 base revision.

18 1.Main Economic Indicators MAIN ECONOMIC AND FINANCIAL INDICATORS (JAPAN) As of Jun 7, 21 Fiscal Fiscal Q 3Q 4Q 1Q JAN FEB MAR APR MAR Real GDP Growth Rate <% changes from previous period at SA annual rate> (-1.1) (4.6) *** *** *** *** *** Index of All Industries Activity -4.5 #N/A #N/A #N/A (-9.3) (-7.) (-3.7) (3.6) (1.9) (4.1) (4.7) #N/A #N/A Industrial Production Index #N/A Production (-27.4) (-19.4) (-4.3) (27.5) (18.9) (31.3) (31.8) (25.9) #N/A Shipments #N/A (-27.3) (-18.8) (-3.3) (26.5) (2.1) (29.) (29.9) (27.3) #N/A Inventory #N/A (-1.3) (-12.1) (-14.6) (-6.) (-12.3) (-7.5) (-6.) (-3.7) #N/A Inventory/Shipments Ratio #N/A (25=1) [13.] [17.3] [123.4] [149.6] [148.9] [154.6] [145.2] [14.3] [14.3] Domestic Corporate Goods Price Index #N/A (-5.5) (-8.2) (-5.2) (-1.7) (-2.2) (-1.6) (-1.3) (-.2) #N/A Consumer Price Index(SA, total, excl.fresh foods) #N/A (-1.) (-2.3) (-1.8) (-1.2) (-1.3) (-1.2) (-1.2) (-1.5) #N/A Index of Capacity Utilization #N/A #N/A (25=1) [14.] [1.4] [87.1] [65.4] [7.5] [62.7] [63.1] [68.8] [72.8] Machinery Orders(Private Demand, #N/A #N/A Excl.Electric Power and Ship building) (-33.4) (-27.3) (-14.) (-1.8) (-1.1) (-7.1) (1.2) #N/A #N/A Manufacturing #N/A #N/A (-47.) (-45.7) (-17.3) (29.) (34.3) (37.2) (21.5) #N/A #N/A Non-manufacturing #N/A #N/A Excl.Electric Power & Ship building (-23.7) (-12.) (-1.8) (-15.1) (-18.3) (-23.4) (-8.) #N/A #N/A Shipments of Capital Goods #N/A (Excl.Transport Equipment) (-41.4) (-34.4) (-21.4) (5.8) (-7.1) (11.3) (11.) (3.7) #N/A Construction Orders (-31.4) (-25.4) (-18.4) (18.7) (15.7) (-2.3) (42.3) (-25.) #N/A Private (-36.) (-27.2) (-2.4) (29.9) (9.5) (-2.2) (75.3) (-31.3) #N/A Public (-14.5) (3.1) (-21.4) (-1.5) (13.7) (-12.8) (-14.3) (-18.9) #N/A Public Works Contracts (13.) (11.2) (6.3) (-11.8) (-3.8) (-8.8) (-16.) (-.1) #N/A Housing Starts #N/A 1, units at Annual Rate, SA (.3) (-25.4) (-31.9) (-35.8) (-2.9) (-6.6) (-8.1) (-9.3) (-2.4) (.6) #N/A Total floor (-2.3) (-21.5) (-29.3) (-31.7) (-15.1) (-3.4) (-3.4) (-8.) (1.) (5.7) #N/A Sales at Retailers (-2.8) (-1.9) (-.7) (3.8) (2.3) (4.2) (4.7) (4.9) #N/A Real Consumption Expenditures #N/A of Households over 2 persons (SA) (-2.3) (-2.3) (-3.2) (-3.2) (1.7) (-.5) (4.4) (-.7) #N/A Propensity to Consume #N/A (SA,%) [74.3] [73.8] [71.9] [74.] [72.8] [74.9] [75.] [74.9] [72.1] Overtime Hours Worked #N/A (All Industries, 5 employees or more) (-18.2) (-14.9) (-7.7) (1.) (4.4) (11.4) (14.5) (1.8) #N/A Total Cash Earnings (Regular Employees Only; All Industries, 5 employees or more) (-4.7) (-3.6) (-4.1) (.) (-.2) (-.7) (1.) (1.5) #N/A Employment Index(Regular Employees Only;'All Industries, #N/A 5 employees or more)(change over the M/Q/Y) [72,912.] [65,668.3] [49,422.3] [-71,698.8] [-62,174.6] [-73,535.8] [-79,386.1] [-82,89.6] [-14,334.8] Ratio of Job Offers to Applicants #N/A (SA,Times) [.94] [.86] [.74] [.59] [.65] [.58] [.53] [.48] [.46] Unemployment Rate #N/A (SA,%) [4.] [4.] [4.1] [4.5] [4.2] [4.4] [4.8] [5.] [5.1] Economy Watcher Survey #N/A (Judgment of the present condition D.I,%) [32.4] [28.5] [19.8] [21.6] [17.1] [19.4] [28.4] [34.2] [36.7] Bankruptcies (Number of cases) 16,146 14,732 3,954 3,782 3,529 3,467 1,63 1,9 1,314 1,154 #N/A (12.3) (-8.7) (3.2) (-6.2) (-13.2) (-17.7) (-21.8) (-17.2) (-14.5) (-13.1) #N/A (Notes) Unless otherwise indicated, tabulated figures and those in parentheses show % changes from previous quarter/month as applicable. The figures in ( ) indicate % changes from previous year. [ ] show the comparable figure of the previous year.

19 2.Balance of Payments As of Jun 7, 21 Fiscal Fiscal Q 3Q 4Q 1Q JAN FEB MAR APR MAR Customs Clearance(Exports in Yen Terms) (-38.6) (-34.4) (-8.) (43.3) (4.9) (45.3) (43.5) (4.4) #N/A Value (-8.) (-12.6) (-6.5) (-.3) (-.3) (-.4) (-.3) (.6) #N/A Volumes (-33.2) (-24.9) (-1.2) (43.8) (41.3) (45.9) (43.9) (39.5) #N/A Imports(In Yen terms) (-39.9) (-39.5) (-2.9) (18.9) (8.9) (29.5) (2.6) (24.2) #N/A Value (-24.2) (-3.8) (-16.4) (5.) (6.6) (5.4) (3.2) (5.6) #N/A Volumes (-2.7) (-12.6) (-5.) (13.1) (2.2) (23.) (16.9) (17.6) #N/A Current Balance(1 mil. yen) 123, ,547 32,514 4,888 34,99 49,46 8,998 14,76 25,342 #N/A #N/A Trade Balance(1 mil. yen) 11,589 66,85 11,678 13,431 2,477 2,499 1,972 7,78 1,747 #N/A #N/A Services(1 mil. yen) -2,469-18,33-6,926-4,278-4,797-2,32-1, #N/A #N/A Capital and Financial Accounts(1 mil. yen) -173,53-123,387-2,73-28,76-17,25-57,331-5,112-14,767-37,452 #N/A #N/A Gold & Foreign Exchange Reserves($1mil.) 1,18,549 1,42,715 1,19,175 1,52,598 1,49,397 1,42,715 1,53,7 1,51,79 1,42,715 1,46,873 1,41,318 Exchange Rate(\/$) Financial Market Indicators Fiscal Fiscal Q 3Q 4Q 1Q JAN FEB MAR APR MAR Uncollateralized Overnight Call Rates [.57] [.51] [.333] [.11] [.12] [.111] [.1] [.14] [.12] Euro Yen TIBOR (3 Months) [.844] [.854] [.831] [.693] [.722] [.77] [.649] [.62] [.572] Newly Issued Japanese Government Bonds Yields (1 Years) [1.642] [1.472] [1.347] [1.293] [1.27] [1.27] [1.34] [1.43] [1.48] Average Contracted Interest Rates on Loans and Discounts(City Banks) #N/A (% changes from previous period) (-.96) (-.13) (-.32) (-.29) (-.9) (-.8) (-.12) (-.7) #N/A The Nikkei Stock Average 8,11 11,9 9,958 1,133 1,546 11,9 1,198 1,126 11,9 11,57 9,769 (TSE 225 Issues) [13,481] [11,26] [8,86] [8,11] [7,994] [7,568] [8,11] [8,828] [9,523] M2(Average) (2.1) (2.9) (2.6) (2.8) (3.3) (2.8) (3.) (2.7) (2.7) (2.9) #N/A Broadly-defined Liquidity(Average) (.1) (.6) (-.1) (.3) (1.1) (1.) (1.1) (.9) (.9) (1.6) #N/A Principal Figures of Financial Institutions Banks & Shinkin (2.4) (.8) (2.9) (1.8) (.2) (-1.6) (-1.5) (-1.5) (-1.8) (-1.8) #N/A Loans and Banks (2.7) (.8) (3.1) (1.9) (.1) (-1.8) (-1.7) (-1.6) (-2.) (-1.8) #N/A Discount City Banks etc. (1.9) (-.4) (2.5) (.8) (-1.3) (-3.5) (-3.4) (-3.3) (-3.7) (-3.4) #N/A (Average) Regional Banks (3.9) (2.4) (4.4) (3.4) (1.8) (.1) (.2) (.1) (-.) (-.1) #N/A Regional Banks Ⅱ (2.4) (1.3) (1.8) (1.7) (1.3) (.3) (.8) (.8) (-.6) (-.2) #N/A Shinkin (.9) (.8) (1.9) (1.4) (.6) (-.6) (-.4) (-.7) (-.9) (-1.1) #N/A Total(3 Business Condition) (1.7) (2.9) (2.7) (3.2) (3.1) (2.7) (3.) (2.9) (2.4) (2.7) #N/A Deposits City Banks (1.7) (3.) (3.1) (3.9) (2.7) (2.5) (2.8) (2.7) (2.) (2.5) #N/A and CDs Regional Banks (1.9) (3.1) (2.7) (2.8) (3.7) (3.3) (3.3) (3.2) (3.3) (3.3) #N/A (Average) Regional Banks Ⅱ (1.3) (1.8) (1.1) (1.4) (2.7) (2.) (2.7) (2.3) (1.1) (1.1) #N/A (Notes) Interest rates are averages. The Nikkei Stock Average is as of month-end. (Sources) Cabinet Office, National Accounts, Machinery Orders; METI, Indices of Tertiary Industry Activity, Industrial Production, Current Survey of Commerce; MOF, Trade Statistics, Balance of Payments; MPMHAPT, Consumer Price Index, Family Income and Expenditure Survey, Labour Force Survey; MHLW, Monthly Labour Survey; Ministry of Land, Infrastructure, and Transport, Economic Construction Statistics; BOJ, Corporate Price Index, Financial and Economic Statistics Monthly, etc.