Japan's first-quarter GDP exceeded expectations: The crisis behind interest rate hikes

According to a recent report by the Australian media "ING Think". Japan's GDP grew by 0.5% quarter-on-quarter in the first quarter, exceeding market expectations of 0.4% and ING's forecast of 0.3%. Although this data demonstrates the short-term resilience of the Japanese economy in the face of the global energy shock, it cannot hide its long-term structural contradictions and policy predicaments. From the perspective of economic logic and market reaction, the Bank of Japan's decision to raise interest rates in June may turn out to be a high-risk game.

Japan's economic growth in the first quarter was mainly driven by the combined forces of private consumption, corporate spending and net exports. Private consumption and business spending both rose by 0.3%, with net exports contributing 0.3 percentage points, demonstrating the short-term synergy between domestic demand and external trade. However, this growth model has significant vulnerabilities. Firstly, the lagging effect of the energy shock has not yet fully emerged. The current data reflects the stage in the early stage of the war when the impact is weaker than expected. Meanwhile, the persistently high energy prices will directly push up import costs, squeeze corporate profits and residents' consumption capacity. Secondly, there are already signs of a slowdown in domestic demand growth. The growth rate for the last quarter was revised from 0.3% to 0.2%, indicating insufficient momentum in consumption and investment. Although government subsidies and wage growth can support consumption in the short term, the rising input costs and increased uncertainty will dampen enterprises' willingness to invest, resulting in an unbalanced structure of "strong consumption and weak investment".

The sharp fluctuations in the Japanese government bond market have exposed the deep-seated contradictions between fiscal and monetary policies. Recently, the sell-off of Japanese government bonds has far exceeded that of other major economies, and the spread between 2-year and 10-year government bonds has widened, reflecting the market's pessimistic expectations for Japan's economic outlook. Prime Minister Ichiro Takashi suddenly called for an additional budget to address energy prices, forcing the government to issue between 5 trillion and 10 trillion yen in new bonds, further intensifying the pressure on the supply of national debt. The continuous expansion of fiscal expenditure and the upward trend of Treasury bond yields form a vicious circle: on the one hand, supplementary budgets are mainly used for energy subsidies rather than economic stimulus, with limited multiplier effects and difficulty in generating endogenous growth momentum; On the other hand, the proposal to lower the food consumption tax and increase defense spending will further push up the fiscal deficit, forcing the Bank of Japan to make a difficult choice between monetary normalization and fiscal sustainability.

The policy path of the Bank of Japan is also highly controversial. Although the real interest rate remains at an extremely low negative level, the decision to raise interest rates needs to weigh multiple risks. From the perspective of the economic fundamentals, although the growth data in the first quarter exceeded expectations, the subsequent quarters will face the triple pressure of ongoing energy shocks, inventory adjustments and a decline in net exports. We have lowered our GDP forecasts for the second and third quarters. The expected full-year growth of 0.7% still depends on the improvement of energy supply and the resilience of consumption, and there is considerable uncertainty. From the perspective of policy effects, a 25 basis point interest rate hike may help stabilize inflation expectations, but it is difficult to fundamentally solve the problem of imported inflation. Inflation in Japan is mainly driven by energy and imported commodity prices rather than overheated domestic demand. Raising interest rates may curb already weak investment and intensify the risk of economic "stagflation".

The policy normalization process of the Bank of Japan lags behind that of major global economies. Its operation of reducing bond purchases has raised market concerns about a tightening of liquidity. If the interest rate hike in June is implemented, Japan will become the last economy among the G7 to start an interest rate hike cycle, but its policy space and market capacity are significantly weaker than those of the Federal Reserve and the European Central Bank. The Japanese government bond market is deeply dependent on domestic investors. Interest rate hikes may lead to funds flowing from the stock market to the bond market, intensifying the volatility of asset prices. At the same time, the debt burden of the corporate and household sectors is heavy. Raising interest rates will directly increase the cost of debt repayment and may trigger a chain default risk.

Although Japan's GDP data for the first quarter exceeded expectations, it is hard to hide the deep-seated contradictions in its economic structure and policy predicaments. Against the backdrop of the ongoing global energy shock, the expansion of fiscal spending and the volatility of the government bond market, the Bank of Japan's decision to raise interest rates in June seems more like a risky "tightrope walking". The effectiveness of its policies not only depends on short-term changes in the situation in the Middle East and energy supply, but also needs to confront long-term challenges such as insufficient domestic demand, poor fiscal sustainability and fragile market confidence. In the collision between economic logic and market reality, every decision made by the Bank of Japan must be made with extreme caution; otherwise, it may fall into a dilemma where "raising interest rates harms the economy and not raising interest rates harms the currency".