Japan's economy is in technical recession after gross domestic product (GDP) shrank in the third quarter, defying expectations for growth and paving the way for Prime Minister Shinzo Abe to delay a second sales tax hike.
World markets traded lower on the news, with stocks in Europe and shares the U.S. falling in early trading.
The world's third-largest economy contracted an annualized 1.6 percent in the July-September quarter, data showed on Monday, compared with a Reuters forecast for a 2.1 percent gain. The economy contracted a revised 7.3 percent in the second quarter.
On a quarter-on-quarter basis, the economy shrank 0.4 percent in the third quarter, worse than the consensus for a 0.5 percent growth.
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Private consumption, which accounts for about 60 percent of the economy, rose a smaller than expected 0.4 percent from the previous quarter, a sign that an increase in Japan's sales tax to 8 percent from 5 percent in April continued to take a toll.
Dollar-yen jumped to new seven-year highs on the news, hitting 117.04 at one point, levels not seen since October 2007. In early New York trading, dollar-yen was around 116.50. Japan's Nikkei 225 closed nearly 3 percent lower.
"The first estimate of the GDP is usually very off the reality, especially we're lacking the import component from the corporate statistics to see the capex, and today's number in the capex was a big drag. So, we have to wait to see what the second estimate is but first impression of the result today is shockingly weak for the economy," Yoshito Sakakibara, executive director of investment research at JPMorgan.
Abe to delay sales tax hike?
The third-quarter GDP print has been highly anticipated after Abe said he will look would look at the data when deciding whether to press ahead with a second increase in the sales tax to 10 percent in October next year, as part of a plan to curb Japan's huge public debt, the worst among advanced nations.
April's hike sent the economy into a tailspin as consumers shut their wallets, and rendered the Bank of Japan's (BOJ) goal of 2 percent inflation by next year ever more remote.
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The BOJ last month shocked markets by expanding its already massive stimulus in an effort to re-energize a fragile recovery and stoke inflation.
"This is absolutely not a situation in which we should be debating an increase in the consumption tax," said Etsuro Honda, a college professor and economic adviser to Abe, told Reuters on Monday. "Debate needs to focus on how to support the Japanese economy."
According to Izumi Devalier, Japan economist with HSBC, a decision could come as soon as Monday.
"We think Prime Minister Shinzo Abe will almost certainly postpone the next VAT increase. The PM is scheduled to hold a press conference on the VAT tomorrow (Tuesday), but we could get an announcement as early as today when Mr. Abe is schedule to return from the G20 meetings being held in Brisbane," Devalier said in a note.
JPMorgan's Sakakibara does not see a deep recession for Japan, but he notes that the rebound remains vulnerable.
"I think the industrial activity is showing signs of recovery and we have very bad weather and natural disasters during summer—that probably had significant impact on the activity. so I guess the recession we seem to have now is likely to be shallow. That said, the momentum of the recovery is still fragile," he said.
Political gamble
Markets are also grappling with the prospect of snap elections, which several media outlets say could happen as soon as next month.
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Abe's Liberal Democratic Party (LDP) looks virtually certain to keep its majority in the lower house, since the opposition is divided and weak, but it could well lose seats.
Postponing the sales tax hike could buy Abe goodwill with voters, although some analysts have cautioned risks to his reform mandate.
"A decision not to go ahead with the 2015 tax hike would probably be seen as a watering down of a key element of Abenomics and could weaken momentum for further reform," analysts from Capital Economics said in a recent report.
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"While markets now seem to regard the tax hike as a negative, questions would soon be raised about the future for monetary policy if the government's commitment to fiscal consolidation was seen to have been abandoned," they added.