Authored by: Adrian Galano, Ella Damasco, Samuel Sia
Edited by: Jared Go, Andrei Dimaculangan, and Elijah Soriano
Latest Economic Data
Philippine Economic Data
BSP keeps RRP held constant at 6.50%
YoY CPI Inflation accelerated to 3.4% in February
Unemployment rate rose to 4.5% in January
US Economic Data
YoY CPI Inflation accelerated to 3.2% in February
Unemployment rose to 3.9% in February
Introduction to Recessions
While there is no official definition for recession, a country is said to be undergoing a technical recession if there is a significant and prolonged decline in economic activity for two or more consecutive quarters, conventionally measured in real gross domestic product (GDP) (Claessens & Kose, 2009; Investopedia, 2024).
It is important to note that economic activity is also measured in other factors, including, but not limited to, employment, sales, production, and real income to determine whether the economy is suffering a recession.
Based on unrevised GDP computations released before March 10, a technical recession has officially been reported in the United Kingdom (UK) and Japan marked by two consecutive quarters of their real GDP contracting (Beattie, 2024). In fact, Japan’s flat economic performance resulted in it dropping to the fourth largest economy, behind Germany. Newly released headlines announced a revision in Japan’s GDP computations which indicate that it managed to avoid a recession, albeit only by a narrow margin.
Figure 1. Real GDP of U.K. from Q1 2019 to Q4 2023
Source: Office of National Statistics (2024)
Figure 2. Real GDP of Japan from Q1 2019 to Q4 2023
Source: Reuters (2024)
Japan Overview
For over 30 years (AKA “The Lost Decades”), Japan has been experiencing a chronic deflation
wherein consumer prices remain flat, contributing to its economic stagnation (TRT World, 2016). Japan experienced multiple financial and economic crises consecutively which put it in deflation regularly. Resultantly, the Japanese are generally used to stagnant prices, and thus, react more strongly to price increases which restricts firms from raising profits significantly. Additionally, Japan’s average growth rate from 2013 to 2022 was reported to be 0.6%, considerably lower than the 1.8% growth rate for other Major Economies (FocusEconomics, 2024). The growth rate has improved, however, in 2023 which was recorded at 1.9%, higher than the previous year’s rate of 2022.
Figure 3. GDP Growth Rate of Japan 2013-2023
Source: Statistic Bureau of Japan (2023)
The BOJ’s Special Policies
Due to the aforementioned economic history of Japan, the Bank of Japan (BOJ) has a unique monetary policy known as Quantitative and Qualitative easing (QQE) which was introduced in April 2013 (Yoshino, Hirasi, Miyamoto, 2017). The quantitative aspect of QQE is primarily focused on increasing money supply through purchases of bonds, while the qualitative aspect refers to purchases of riskier assets such as stock market ETFs and REITs. In addition to QQE, the country implemented Negative Interest Rate Policy (NIRP) as well in 2016.
QQE and NIRP were not enough though and hence, the BOJ added a third measure known as Yield Curve Control (YCC) in 2016. This complex framework aims to stimulate economic growth and control inflation by manipulating short, medium, and long-term bond yields. In particular, it aimed to exceed its 2% target inflation rate as a way to curb deflation by buying or selling Japanese government bonds (JGBs) or other financial assets.
Effects of Special Policies
As shown by the earlier chart on Japan’s real GDP growth trends, these policies were unable to propel the growth of Japan’s economy, and it remained in stagnation. As shown by the graph below, inflation remained below the 2% consistently over the last decade as well.
Figure 4. Japan CPI inflation rates
Source: Statistics of Japan (2024)
While the effect on GDP growth and inflation was minimal, these policies did have an important impact on other aspects of the economy. Given the unattractiveness of JGBs due to their low yields, Japanese investors gravitate more towards higher yielding foreign government bonds that are still safe. Because of this, Japan holds approximately 14.5% of foreign-owned US treasuries, making it the largest buyer of the said asset (Bloomberg Quicktake, 2023).
This preference of foreign debt led to the depreciation of the Japanese yen (JPY) as well. In order to purchase US government bonds, US Dollars (USD) first have to be purchased. As Japanese bought more USD in exchange for JPY, this contributed to the USD’s appreciation over the decade, and the depreciation of the JPY.
The Present YCC Policy
As part of its YCC policy, the BOJ set the short-term bonds at a negative yield around -0.1%, while long-term bonds are higher with the 10Y bond having a yield of 0.73%.
Figure 5.
Japan Yield Curve for varying durations of Japanese Government Bonds as of March 7, 2024
Source: World Government Bonds (2024)
In July 2023, the BOJ increased its flexibility in YCC policy by having 1% as an upper bound, while still maintaining the target level at 0% (Jie, 2023). It follows that the market expects that the BOJ may ease out its NIRP program in Spring due to increasing inflation in the country and decreasing value of the Japanese Yen (atomos, 2023). Furthermore, in mid-2023, the central bank was reported to be considering phasing out the YCC program. A debate ensues about whether or not this policy change will significantly affect the global market.
Figure 6. Nikkei 225
Source: TradingView (2024)
As stated earlier, unrevised GDP data suggested that Japan fell into a technical recession for the second half of 2023. This was driven by weak domestic demand overall due to stagnant wage growth not keeping up with rising prices. In other words, real wages did not grow.
Despite the announcement of Japan’s technical recession, the Nikkei 225 rallied throughout the second half of February. Furthermore, it went above the 40,000 level, breaking its previous all-time high in 1989. This shows that the primary driver of Japan’s stock market is not necessarily current economic growth numbers, but other prospects that are appealing to foreign investors. A weaker yen has allowed investors to purchase stocks at a cheaper price, driving up demand and in turn, the stock market as well (Shan, 2024). Strong earnings and the shift away from YCC were other main contributing factors to the rally (Nagata, 2024).
UK Overview
The Bank of England (BoE) has reported seeing an inflationary trend in the prices of goods and services since 2021 because of three factors: (1) COVID-19 pandemic, (2) Russia’s invasion of Ukraine, and (3) Labor shortage (Bank of England, 2024). These negative supply shocks wherein there exists a shortage of goods and services which inevitably results in rise of prices in the economy. Most notably in the U.K., the disruptions in the oil and energy supply are the main drivers of price.
Figure 7. U.K. Inflation rate from Q1 2019 to Q1 2024
Source: Office for National Statistics (2024)
As of January 2024, the U.K. inflation rate is still higher than its target rate of 2% but is seen to be steadily dropping as observed in Figure 6.
The BoE imposed high interest rates to address inflation, but these also disincentivized consumers from spending money. The combination of high interest rates with negative supply shocks contribute to the contraction of the country’s GDP, resulting in a technical recession.
UK Recession Drivers
As stated earlier, the UK fell into a mild recession during the second half of 2023. The recession is mainly attributed to the doctors’ strike in the health sector, the 1% decline in school attendance, and lower consumer spending (Jordan & Islam, 2024). In the fourth quarter of 2023, a slowdown occurred in all main sectors, including the manufacturing and construction sector. According to Pranesh Narayanan, a research fellow at the Institute for Public Policy Research, the underlying factor of the recession is the long-term underinvestment in schools, hospitals, and infrastructure (Al Jazeera, 2024).
Figure 8. Financial Times Stock Exchange (FTSE) 100 Index
Source: TradingView (2024)
Despite the announcement of a recession in the UK, the FTSE 100 Index (UK’s primary stock market index) was not largely affected given its performance throughout the month. This gives the implication that the market may have already expected this recession to happen. One still has to see whether promises and policies that will be implemented from the government and BoE may drive the economy away from the recession. The future performance of monetary and fiscal policy may drive the stock market in the future depending on how they affect the economy.
Conclusion
Given recent statements, actions, and expectations from the BOJ, it is possible Japan may exit the era of NIRP and YCC.
The time when this gets fully implemented heavily depends on the progression of GDP, inflation, and other metrics over the next few months. Furthermore, the shift may have a significant impact on the global bond market. If done too quickly, a large sell-off of US government bonds may occur which pushes yields upward.
The inflation rate in the U.K. is reported to be 4% as of January 2024 — twice the inflation target of 2 — regardless of the monetary policies imposed by the Bank of England. Since the BoE is currently focused on addressing inflation, the market can expect that the BoE’s Monetary Policy Committee may enforce rate cuts once the target rate of 2% is nearly achieved or has already been achieved. This means that the recession is temporary due to interest rates becoming less restrictive to stimulate economic activity.
References
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