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Japan's August machinery orders bodes well for durable recovery

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Japan took another step forward to solidifying a durable economic recovery, as core machinery
orders rose faster-than-expected in August, providing a welcome sign for capital spending seen as vital for achieving sustainable growth.

The 5.4 percent month-on-month rise in core orders, which exclude those of ships and electric power utilities, was the first rise in three months, data from the Cabinet Office showed on Thursday. It also beat economists' median forecast for a 2.0 percent gain and followed a slight fall in July.

The outcome is an encouraging sign for Prime Minister Shinzo Abe, who is hoping the positive mood generated by his reflationary policies, dubbed "Abenomics", will lead to a virtuous cycle of higher capital spending, growth in wages and private consumption.

The government and the Bank of Japan see a recovery in-capital spending as a key in driving a sustained economic recovery and breaking 15 years of grinding deflation, paving the way for the ultimate success of Abe's policies.

(Read more: SocGen: Don't let the shutdown distract you from Japan)

Growth so far this year suggests that the recovery in the world's third-largest economy is solidifying, although the jury is still out on whether capital spending is about to take a decisive turn for the better.

Second quarter gross domestic product data last month showed capital spending rose 1.3 percent, marking the first increase in six quarters. "The (machinery) data confirmed a recovery in capital spending led by non-manufacturers, reflecting effects from Abenomics," said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo.

Japan's economy expanded for three straight quarters in April-June, outpacing other G7 nations with an annualized growth of 3.8 percent, as the government's aggressive policies bolstered household spending and drove down the yen, benefiting exports.

Analysts expect companies to spend more on plant and equipment in the coming months as the BOJ's key tankan survey showed earlier this month confidence among big manufacturers hit its highest in nearly six years in the third quarter.

(Read more:BOJ to stand pat, stick to upbeat economy view despite tax rise)

For years Japanese firms have been hoarding cash, instead of spending on plants and equipment or raising salaries, due in part to the view Japan would remain mired in deflation, bringing their total cash pile to some 220 trillion yen ($2.26 trillion).

Despite signs of a recovery in capital spending, many firms remain reluctant to raise wages in defiance of Abe's call to boost salaries, casting doubts about the sustainability of the economy's recovery.

Data showed this month wage earners' total cash earnings fell year-on-year for the second consecutive month in August, with regular pay down for 15 months in a row, a sign a sustained rise in wages is far from assured despite a rise in bonuses.

Underlining tame cash demand among companies, Japanese bank lending grew just 2.0 percent in the year to September, separate data from the Bank of Japan showed on Thursday. The Cabinet Office raised its view on machinery orders, saying they are picking up, from its previous view it was increasing moderately.

(Read more: Bank of Japan maintains stimulus, more upbeat on capex)

The BOJ, which offered an intense burst of monetary stimulus in April to achieve 2 percent inflation in two years, also revised up its assessment of capital expenditure on Friday to say it is picking up. The Cabinet Office data showed orders from manufacturers rose 0.8 percent, while those from the services sector increased 6.2 percent, underscoring firm domestic private consumption.

Compared with a year earlier, core orders, a highly volatile data series regarded as an indicator of capital spending in the coming six to nine months, grew 10.3 percent in August, above economists' median estimate for a 8.7 percent gain.

Still, underscoring the challenges facing policymakers, some analysts remain doubtful that the positive momentum can be sustained given companies' reluctance to raise wages. "This data is certainly positive for Abenomics but it just points to the beginning of the positive cycle and I doubt it can be sustained given sluggish wages," said Naoki Iizuka, economist at Citigroup Global Markets Japan.

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