Japan's economy shrank late last year, defying expectations of modest growth and plunging the country into recession.
Japan's weaker-than-expected economy in the fourth quarter was the result of a slowdown in spending by businesses and consumers struggling with inflation at its highest in four decades, a weak yen and rising food prices.
The end of the year also marked an expected moment: Japan's economy, now slightly smaller than Germany's, fell a notch to become the world's fourth largest.
On an annual basis, gross domestic product fell 0.4 percent in October-December, after a revised 3.3 percent decline in the previous three months. Economists had forecast growth of around 1 percent for the fourth quarter.
The numbers cloud the outlook for Japan's economy. Corporate profits are at record highs, the stock market is booming and the unemployment rate is low. But consumer spending and business investment — two key drivers of the economy — are lagging.
Shinichiro Kobayashi, chief economist at Mitsubishi UFJ Research and Consulting, said the economy was “polarized” due to higher prices. As corporate profits rise, goods prices rise, but wages don't keep up and consumers are reluctant to spend, he said.
A big question will be whether Japanese workers can get a significant wage increase this year.
“The ball is the court of the corporate sector,” Mr. Kobayashi said.
The two consecutive quarters of negative growth mean the economy is technically in recession, but the numbers are preliminary. A large enough upward correction could shatter the recession label.
The weak economic data also complicates an upcoming decision by the Bank of Japan on whether to proceed with the country's first interest rate hike since 2007.
Japan's central bank has stubbornly stuck to policies aimed at keeping interest rates low and boosting spending – a remnant of its long-running battle against deflation. Many economists had speculated that the central bank might finally change course as early as April, when the economy appeared to be on stronger footing.
Marcel Thieliant, head of Asia Pacific at Capital Economics, wrote in a research note that he “doubts” that the disappointing fourth-quarter numbers will prevent the Bank of Japan from ending negative interest rates in April, even if economic growth continues until will remain “sluggish” this year.
The persistently weak Japanese yen remains a sensitive issue for the central bank. The reduced purchasing power of the currency is causing the cost of goods imported into Japan to rise, adding to the inflationary pressures felt by consumers. However, it tends to help the bottom line of many leading Japanese companies that sell goods abroad and bring those foreign profits back into the country in yen.
By standing firm in recent years even as the European Central Bank and Federal Reserve raised interest rates, the Bank of Japan's policies have exacerbated the yen's weakness. This has made it attractive for global investors to borrow yen in Japan at very low interest rates and then invest those funds in dollars or euros in the West at much higher interest rates.
Saisuke Sakai, senior economist at Mizuho Research & Technologies, said it appeared likely that the domestic economy would contract again in the first three months of this year due to disruptions from January's massive earthquake that hit western Japan – a region with many manufacturing centers .
This could impact consumer sentiment even more.
“If we had negative growth for three quarters in a row, people would ask themselves, 'Is the Japanese economy really OK?'” Mr. Sakai said.
With the release of its year-end gross domestic product figures, Japan also relinquished its place as the third-largest economy behind the United States and China, a position it had held since being overtaken by China in 2010. Germany now has this distinction in relation to the US dollar, which is the most important currency in world trade and finance.
In fact, the German economy is also weakening. Germany's decision to stop buying cheap Russian natural gas and oil after Russia's invasion of Ukraine has sent energy costs sharply higher, even as the country has switched to suppliers in the Middle East, the United States and elsewhere.
Japan could lose its spot at No. 4 in the coming years as its shrinking population struggles to keep up with the growth of India, the world's most populous country.
Keith Bradsher contributed reporting.
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