The annualized 1.8 percent GDP growth in the April-June period — the third quarter in a row with growth — does not appear to warrant optimism over the course of the Japanese economy in the coming months. The 0.6 percent increase in private consumption was aided by robust travel and other leisure spending during the 10-day holiday spell from late April to early May, a one-off measure that accompanied the imperial era transition from Heisei to Reiwa, while the intensifying trade row between the United States and China spells greater uncertainties regarding overseas markets and corporate earnings.

April-June growth was faster than the forecasts of many private economists: Solid domestic demand, led by consumer spending and business investments, made up for a 0.1 percent dip in exports, which reflected the decelerating growth in the world economy. Capital investments rose 1.5 percent for the third straight quarterly gain as firms poured more money into manpower-saving investments to cope with the labor-supply shortage.

However, it’s doubtful that the strong consumer spending will be sustained once the special effects of the extended Golden Week holiday wear off — and given the underlying weakness in private spending and the consumption tax hike to 10 percent in October, which was twice postponed to avert negatively impacting the economy. Also, it remains to be seen whether the business appetite for more domestic investment will be sustained at a time when exports bound for Asian markets are taking a hit from the slowdown in China’s economy amid the trade dispute with the U.S.

Other economic indicators point to growing caution among Japanese firms, whose profits have reportedly been falling in recent months as they face tougher prospects in overseas demand. The business sentiment of large manufacturers in the Bank of Japan’s tankan survey in June worsened for two quarters in a row to the lowest level since September 2016. A Kyodo News survey of 112 major firms shows that only 23 percent of them say they believe Japan’s economy is expanding — a steep fall from the 78 percent that believed so just a year ago.

Hopes that the world’s largest and second-largest economies are heading for a truce in their bitter trade war were dashed when U.S. President Donald Trump in late July announced a pending imposition of punitive tariffs on $300 billion more Chinese imports — just a month after he agreed with Chinese President Xi Jinping to resume bilateral trade talks — and followed up by calling China a “currency manipulator.”

Further escalation in the U.S.-China trade dispute and a resulting slowdown in global growth will put more strain on the Japanese economy by curbing exports. Fears are also growing that turbulence in financial markets due to the trade row could lead to a spike in the yen’s value against the dollar, along with moves by central banks, including the U.S. Federal Reserve, to cut interest rates. A steep appreciation of the yen would hurt the profits of major export-driven firms, which for years benefited from the weak yen under the BOJ’s massive monetary stimulus program and robust demand in overseas markets.

The last consumption tax hike to the current 8 percent in April 2014, which resulted in a 4.8 percent fall in consumer spending and the GDP contracting 7.2 percent in the April-June period that year from the preceding quarter, threatened to derail the nascent recovery of the economy. This time the negative impact on the economy is forecast to be smaller, given that the margin of the hike is narrower and since the Abe administration has taken a variety of measures to minimize damage to the economy. Still, concern persists that the upcoming tax hike could dampen consumer spending and drag down the economy. Economists suggest that the underlying trend of private consumption is weaker than when the tax was last hiked five years ago.

The government and the BOJ say they will not hesitate to take additional steps if the downside risks to the economy materialize. Since fiscal and monetary policies have already been explored in the 6½ years of Abenomics, however, there is concern that few policy tools are left — particularly in terms of monetary policy — to revamp the economy.

Given the deepening U.S.-China trade row and the darker clouds over the world economy, Japan has no choice but to explore domestic demand-led growth in a sustainable way instead of relying on special on-off effects. The government must pursue policy measures that have not been explored sufficiently under Abenomics, such as structural reforms to raise the economy’s growth potential. Decelerating global growth is testing Japan’s efforts toward sustained growth driven by domestic demand.

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