11/16/2014 07:10 EST | Updated 01/17/2015 05:59 EST

Japan Recession Undermines Global Growth Prospects

TOKYO - Japan's economy unexpectedly shrank in the third quarter as housing and business investment declined following a tax hike, dragging the country into a recession and further clouding the outlook for the global economy.

The world's third-largest economy contracted at a 1.6 per cent pace in the July-September quarter, the government said Monday, contrary to predictions it would grow after a big drop the previous quarter. The surprise deepens uncertainty when China's growth is slowing and the 18-country eurozone grew only 0.2 per cent in the same quarter.

The gross domestic product figures showed across-the-board weakness in demand among consumers, manufacturers and builders. Many individuals and companies had spent money before the sales tax was hiked in April from 5 per cent to 8 per cent, and spending has languished since then.

"The impact of the sales tax was much more severe than expected," said Junko Nishioka, an economist at RBS Japan Securities.

Housing investment plunged 24 per cent from the same quarter a year ago, while corporate capital investment sank 0.9 per cent. Consumer spending, which accounts for about two-thirds of the economy, edged up just 0.4 per cent.

Given the contraction, Prime Minister Shinzo Abe is expected to put off another sales tax hike planned for next October, slowing progress on efforts to rein in Japan's government debt, the largest among industrialized nations.

He also will likely make the dismal GDP reading the basis for calling a general election in mid-December to underpin the public mandate for his "Abenomics" policies of lax monetary policy, fiscal spending and structural economic reforms.

Japan emerged from its last recession just as Abe took office in December 2012, vowing to restore the nations' economic vigour after two decades of stagnation.

But the country is struggling to regain momentum as its population declines and ages. Apart from its automakers, many of its manufacturers have lost their leading edge in innovation while shifting production to cheaper locations offshore.

Household incomes, meanwhile, peaked more than a decade ago, and a growing share of workers are having difficulty making ends meet with part-time, contract work. Wage increases — mostly limited to a small share of workers in big-name companies — have lagged behind inflation.

Most economists had forecast that Japan would expand at about a 2 per cent pace after a sharp 7.1 per cent annual pace drop in April-June immediately following the tax hike. A recession commonly is regarded as two straight quarters of economic contraction. Compared to the previous quarter, GDP declined 0.4 per cent.

While delaying the next tax hike could undermine confidence in Japan's ability to repair its battered finances, Abe and his advisers appear to view the threat to Japan's recovery as the more urgent risk.

In early 2013, Abe and Bank of Japan Gov. Haruhiko Kuroda united in seeking to end the long spell of deflation that they say is discouraging companies and consumers from spending money.

So far, price increases have fallen short of their inflation target of 2 per cent, with most of the increases coming from the sales tax hike and from higher costs for imports due to extreme monetary that has helped drive the value of the Japanese yen to seven-year lows against the U.S. dollar.

On Oct. 31, Kuroda announced the central bank would step up its asset purchases, accelerating Japan's "quantitative easing" just as the U.S. was ending its own asset purchases. Despite that surprise move, Kuroda has insisted that the economy is still in the midst of a "moderate recovery."

The BOJ's move, along with a government decision to shift a large share of the public pension fund investments out of government bonds and into higher yielding but riskier shares, pushed Japan's share benchmark to seven-year highs this month.

But in morning trading, the Nikkei 225 stock index tumbled 2.6 per cent to 17,037.65.

Monday's data is preliminary, with a revision due Dec. 8. Since some of the decline was due to reductions in inventory, things may not be as bad as the GDP reading suggests, economists said.

Pierre Ellis, senior economist at Decision Economics in New York, said increased business orders in the past three months for machinery, industrial equipment and other big ticket items should boost output in the coming months.

Abe already was expected to announce additional economic stimulus this week. The dismal Monday morning data will probably lead him to announce a package worth about 3 trillion yen to 4 trillion yen ($26 billion to $35 billion), Nishioka said.

That could include subsidies to low-income families and help for small and medium-sized companies that rely on imported components and energy that have suffered as the Japanese yen has weakened from about 80 to the dollar to its current level of about 116 to the dollar — a move that has helped exporters.

Critics say Abe has failed to deliver on promises for drastic reforms of labour regulations, the tax system and the health industry, among other areas. Meanwhile, companies have largely refrained from passing windfall gains from share price gains and surging profits on to their workers in the form of higher wages.


AP Economics Writer Christopher S. Rugaber in Washington contributed to this report.

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