The Prime Minister Shinzo Abe's coalition is likely to retain its majorityin October's snap election, boding well for policy continuity. The mainrisk stems from a surge in support for the new Party of Hope, whichcould channel disgruntled voters and dash Abe's hopes of remainingin office beyond 2018.
The surge in Japanese real GDP growth in Q217 was ostensibly drivenby domestic demand, but the ongoing recovery in global growth remainsa key supportive factor. We have revised up our forecast for Japan's2017 real GDP growth to 1.8% from 1.3% previously, which wouldmark the fastest pace of growth since 2013. Strong profitability andhigh levels of business confidence could sustain above-potential GDPgrowth in H217, but rising oil prices and growing domestic economicdistortions lead us to maintain our 0.5% 2018 growth forecast.
Japan's current account surplus will face downward pressure from adeterioration in the country's terms of trade, a persistent fiscal deficit,and a decline in the private sector savings rate amid an ageing population.
These factors should gradually erode the current account surplus,removing one of the economy's major pillars of strength.
The BoJ's decision to maintain its monetary policy stance at its September21 meeting came as little surprise, and we expect the currentpolicy to remain in place for a long while to come. However, we believethat policymakers are falling further behind the curve with regards toinflation potential, which we expect to rise sharply.
The prevailing wisdom among Japanese policymakers and academics,as well as international academics advising the Abe administration, isthat weak growth requires the government to run larger budget deficits,and strong growth suggests large budget deficits are working and sothey should be continued. As such, we continue to see governmentspending rising, to the detriment of economic growth.
Recent strength in the yen has failed to dent bearish speculativepositioning, but we do not see this as a major obstacle to renewedweakness. Upside pressure on US bond yields is likely to cause yenselling in the near term, while the lack of any credible exit strategy bythe BoJ suggests that monetary policy will remain extremely loose untilinflationary pressures rise, and most likely beyond.
Major Forecast Changes
We have not made any major changes to our forecast since thelast Japan Country Risk Report. We maintain that inflation is likelyto rise much more sharply than consensus expectations, while therecent acceleration in growth is unlikely to last.