Latest data from Japan paint a bleak outlook for an economy that started the year on a strong footing and suggest the cautious Bank of Japan (BOJ) may now have little option but to ease monetary policy again, analysts say.
Japan’s industrial outputfell for a second straight month in August, declining 1.3 percent — a much steeper fall than the 0.5 percent drop anticipated by economists, data on Friday showed. Japan’s Ministry of Economy, Trade and Industry meanwhile said factory output was now in a weakening trend, revising its previous view that output had stabilized.
“The weakness of the economy may require the Bank of Japan to take more action,” said Masayuki Kichikawa, Chief Japan Economist at Merrill Lynch Japan Securities in Tokyo.
“I think the Bank of Japan will continue to consider whether the monetary easing decided at the last meeting will be enough to prevent the recent weakness in production from delaying the country’s escape from deflation,” he told CNBC Asia’s“Squawk Box”.
The BOJ, which analysts say tends to veer on the side of caution, surprised financial markets last week when it eased monetary policy by boosting asset purchases. It also warned that the economic recovery it anticipated for the last few months of the year could be pushed back by six months.
Some analysts expected the BOJ to follow up last week’s move with further stimulus measures next month, especially against a backdrop of deflation. Japan’s core consumer price index fell a bigger-than-expected 0.3 percent in the year to August, showing that deflation continues to persist, data on Friday showed.
“The bigger message is that Japan’s economy remains mired in deflation and although we saw that easing from the Bank of Japan earlier this month, the pressure is still on for some additional action – probably not at the meeting we get at the end of next week, but maybe towards the end of October,” Ray Attrill, Co-Head of FX Strategy at National Australia Bank told “Squawk Box,” referring to meetings of the BOJ scheduled for October 4-5 and October 30.
“So the pressure is still on,” he added.
Against a generally weak backdrop for the world economy, Japan started the year on a strong note with growth underpinned by robust demand at home and a boost from heavy spending after last year’s devastating tsunami and earthquake.
But concerns about the outlook for the world’s third largest economy have grown in recent months because of persistent strength in the yen which is denting exporters’ competitiveness, a sharper-than-expected slowdown in China, Japan’s largest export market, and a crisis in the euro zone that has undermined the outlook for growth globally.
Indeed, the yen , which hit a seven-month high against the dollar earlier this month, is widely seen as a big reason behind the BOJ’s latest easing measures. Now more signs of weakness in the economy are expected to spur the central bank to action again.
“After a blistering start to 2012, Japan has hit a speed bump along its way to recovery,” Izumi Devalier, an economist at HSBC wrote in a research note earlier this week.
Japan’s economy grew 0.2 percent in the third quarter from the previous quarter, after growing 1.2 percent in the first quarter.
“With the economy at risk of stalling further in 2012 and mild deflation expected to persist until mid-2013, we see a bias towards more action by the BOJ,” Devalier said in the note.
The BOJ was likely to expand its asset purchasing program by another 5 trillion yen ($64 billion) by the end of the year, Devalier said. Last week the BOJ boosted its asset-buying and loan program by 10 trillion yen to 80 trillion yen.
Some analysts expressed surprise that Japan has not done more to boost its economy.
"It seems to me Japan’s challenges grow and grow and grow," said Jim O'Neill, chairman of Goldman Sachs Asset Management at a press conference in Singapore on Friday, adding that the BOJ could do with borrowing Federal Reserve Chairman Ben Bernanke, who unveiled aggressive stimulus measures earlier this month to revive U.S. growth.
"The BOJ has superficially adopted a 1 percent inflation target. They have got to start getting serious about it – the only way they can get any real impetus is if they get a lot more aggressive, including deliberately weakening the yen," O'Neill said. "I look from a distance and I cannot understand why they aren’t more active."
Analysts said they would also be watching Tokyo’s policy makers closely for signs of an additional budget to bolster the economy.
“At this moment the idea which is being floated in the market in Tokyo, is that the government will probably put together another supplementary budget to continue to hold and support the economy from the domestic side,” said Kichikawa at Merrill Lynch Japan Securities.
Japan passed three sets of supplementary budgets last year totaling some 18 trillion yen ($230 billion) and the Japanese parliament approved a fourth budget earlier this year for 2.5 trillion yen ($32.9 billion) to fund reconstruction projects and support the economy.
- By CNBC's Dhara Ranasinghe with additional reporting by Ansuya Harjani