Due to weak domestic demand, Japan’s economy shrank for a second quarter before abruptly entering a recession. As a result, some observers of the central bank have retracted their predictions on the end date of the country’s negative interest rate policy.

The Cabinet Office released a report on Thursday showing that the gross domestic product shrank at an annualised pace of 0.4% in the last three months of the previous year, after declining 3.3% in the previous quarter.

According to the research, Japan’s economy shrank to become the fourth largest in the world last year in terms of dollars, and both people and corporations reduced spending for a third consecutive quarter. Germany currently boasts the third-largest economy in the world.

Out of 34 economists surveyed, only one predicted a contraction for the quarter; the consensus was 1.1% increase. Following the announcement, overnight swaps revealed that markets were pricing in a roughly 63% possibility of a hike by the Bank of Japan by April, down from 73% the day before.

The BOJ’s argument for the first rate hike in Japan since 2007 will be made more difficult by the less-than-expected outcome, which most analysts polled last month anticipated the bank would take by April.

The economist of Norinchukin Research, Takeshi Minami, stated that “this is a headwind for the BOJ.” “A north wind is currently blowing, but I think there is a feeling that the BOJ will end the negative rate in March or April.”

The policy board of the Bank of Japan has intensified its deliberations over the withdrawal from the sub zero rate policy, aiming to reassure investors that a raise in interest rates would not signify a drastic change in strategy.

Echoing one of his deputies, Shinichi Uchida, Governor Kazuo Ueda told parliament this week that Japan’s financial conditions will stay accommodative for the time being even after the end of the negative interest rate.

Economist Taro Kimura stated, “The unexpected decline in fourth-quarter GDP places Japan in a technical recession and raises serious questions about whether the Bank of Japan will heed signals it sent in January pointing to a swift retreat from its current policy stance.”

The figures released on Thursday demonstrated the need for loose policy by highlighting Japan’s dependence on foreign demand while domestic demand wanes due to ongoing inflation.

Private consumption fell by 0.2% as consumers tightened their budgets in response to growing living expenses. For the tenth consecutive month, household expenditure decreased in December compared to the same month last year, with pay increases falling short of inflation. The previous quarter’s business spending was likewise weak, down by 0.1%.

According to Minami, “stuck inflation is reducing consumers’ purchasing power, resulting in weak consumption.” “It resembles mild stagflation.”

The decline in consumption, according to Itochu Research Institute senior economist Atsushi Takeda, was startling. Takeda remarked, “I was shocked by these results.” “The price increase had a greater effect than anticipated.”

Takeda stated that while he still anticipates a move in April, the likelihood of a BOJ rate hike in March is now all but erased.

In the upcoming months, there is a risk that the yen’s reversal to levels not seen since November would increase cost-push inflationary pressure. Japan’s yen had minimal movement in relation to the US dollar following Thursday’s report, trading around 150.40.

Growth was boosted by net exports by 0.2 percentage points. December saw a spike in exports, driven mostly by cars going to the US and equipment for making chips going to China. As a subset of service exports, inbound tourism also continued to expand, with December seeing a record number of tourists.

Looking ahead, given that development is predicted to slow down in some of Japan’s major trading partners in 2024, external demand may become a less dependable source of support for growth. The BOJ stated that the economy “is expected to be under downward pressure stemming from a slowdown in the pace of recovery in overseas economies” in its most recent quarterly outlook, which was released last month.