Decline in Japanese GDP in Q1, a new coalition in Italy and impact of potential reforms, PBoC report

Macro Highlights - 5/23/2018

In short
  • In Japan, the GDP growth decline in Q1, which led to a slowdown in annual growth from 1.8% to 0.9%, should support the BoJ in continuing its accommodative monetary policy
  • In Italy, the new government coalition has agreed on three reforms that would weigh on public finances, but whose effect on yields could nevertheless be contained by ECB bond purchases
  • In China, in addition to focusing on the management of financial risks, the central bank is likely to maintain a bias favouring GDP growth in order to reach a level of close to 6.5% in 2018

In Japan, the slowdown in annual GDP growth should support the BoJ in continuing its accommodative monetary policy

After eight consecutive quarters of expansion, Japanese GDP contracted in Q1 2018. While exceptional factors such as harsh weather conditions partly explain this trend, the significant downward revision of GDP figures in Q4 2017 nevertheless also confirmed the weakness of domestic fundamentals. This weaker activity is set to support the Bank of Japan (BoJ) in continuing its very accommodative monetary policy.

Japanese GDP contracted by 0.2% in Q1 2018. Moreover, its Q4 2017 growth figure was revised down from 0.4% to just 0.1%. As a result, year-on-year GDP growth was at 0.9% in Q1 2018, after 1.8% in Q4 2017 and 1.7% on average in 2017.

This downturn in Q1 resulted from the weakness of private domestic demand. Business investment and household consumption notably dropped by 0.2% and 0.1%, respectively, while residential investment declined by 2.1%. While poor weather conditions contributed to this unfavourable trend, the sharp downward revision of household consumption for Q4 2017 (for which growth was revised from 0.5% to 0.2% for the quarter) and business investment (for which the quarterly rise was lowered from 1.0% to 0.6%), as well as the confirmation of the sharp drop in residential investment (down 2.7%) nevertheless confirmed the less dynamic trend in private domestic demand.

Thus, while public demand stagnated in Q1 2018, the main driver of Japanese growth was foreign trade, which contributed 0.1 points to the quarterly change in GDP, despite a deceleration in exports (which were up 0.6% after 2.2%) and thanks to the slowdown in imports (up 0.3% after 3.1%).


  • Japanese Q4 2017 and Q1 2018 GDP data reflect weak domestic demand. This trend, along with the confirmed weakness of inflation (the BoJ’s preferred measure of inflation, which excludes fresh food and energy, decelerated from 0.5% to 0.4% in April), should support the BoJ in continuing its accommodative monetary policy.
  • We thus keep unchanged our forecast according to which the BoJ would maintain its key rate at 0.1% and its target 10-year JGB yield at close to 0.00% in 2018 and in 2019.

In Italy, a government project that would weigh on public finances

In Italy, the Five Star Movement and League parties have agreed on a political programme for the next five years that could raise political uncertainty. This would weigh on Italy’s economic activity, with zero growth potential due to low productivity and an ageing population; impact public finances, carrying debt as high as 131.2% of GDP; and add new risks to a banking system burdened by NPLs exceeding EUR288 billion.

The agreement notably defined three priority reforms.

  • A reversal of the pension reform which would make retirement possible from the age of 64, or after 36 years of contributions, vs. the current retirement age of 66.7 for 2018 and 67 for 2019. This possibility would call into question the benefits of the reform laws of 1992 and 1995, which currently enable Italy to be unburdened of additional pension charges up to 2030 despite the ageing of its population.
  • The introduction of a universal income of EUR789 per month, which would affect the public deficit, which is nevertheless decreasing (-3.0% in 2014 and -1.7% in 2018).
  • The introduction of a flat tax rate of 15% for both businesses and individuals which would reduce the tax burden considerably. This would lead to a significant drop in tax revenues, which represent 42.9% of GDP, 25.8% of which notably correspond to income tax, for a current average taxation rate of 26.6% of gross median income, and 4.97% to corporate tax, the rate of which had already been lowered from 31.4% to 24% in 2017.

Thus, assuming a cost of EUR50 billion for public finances, these measures would imply an increase in the share of public deb t in GDP of 2.9 points. And this does not take account of the possibility of a rise in interest rates that would weigh on the capacity to refinance debt. However, the rise in bond yields could be contained by larger purchases of Italian debt by the European Central Bank, according to our analysis.


  • The political uncertainty in Italy calls into question the structural reforms of the pensions system, which up to now guaranteed the sustainability of the public debt despite an ageing population.
  • In reaction to a possible deterioration of public finances, the rise in interest rates could nevertheless be contained by the European Central Bank if the latter were to increase its purchases of Italian debt as part of its sovereign bond purchase programme.

China – the PBOC could pause its efforts in managing the country’s financial risks

In China, the central bank (People’s Bank of China, or PBoC) published its report for the first quarter of 2018. The report n oted the solidity of the country’s economic fundamentals, which are able to sustain durable, high-quality growth. The PBoC also stated its confidence in an inflation environment that is set to remain stable in 2018. Chinese inflation did indeed come in at 1.8% in April, well below the Central Bank’s target of 3%. Regarding its monetary policy, the PBoC reiterated its intention to maintain reasonable liquidity levels, in relation to its desire for monetary stability. Compared to Q4 2017, the bank also le ft out the terms “deleveraging” and “financial regulation” from its report, suggesting that the pressure put on by Beijing to further control the issuing of credit and strengthen the management of financial risks could be lightened in the next few months. If it were to be confirmed, this pause, would nevertheless be temporary. These factors seem to show that, while seeking more inclusive growth, tighter control of financial risks and the deleveraging of the Chinese economy, Beijing maintains a bias in favour of domestic growth, alongside China’s ambition to achieve real growth of close to 6.5% in 2018.