Diminishing capacity shortages unlikely to prompt rate cuts by BoJ, says Capital Economics

The Bank of Japan has signalled that it would not loosen policy in response to a temporary slowdown in demand as long as capacity shortages remained pronounced, according to the latest research report from Capital Economics.

Data released this week show that this was indeed the case on the eve of the tax hike: the Bank’s estimate put output 1 percent above its sustainable level in Q3, unchanged from Q2. A small fall in “capital utilisation” was offset by a renewed rise in “labour utilisation”.

GDP is expected to have fallen by 0.7 percent q/q in the fourth quarter as domestic demand slumped after the sales tax hike. However, we suspect that the Bank’s output gap estimate won’t fall as much. Manufacturing capacity utilisation slumped as output in the sector plunged by around 4 percent q/q in Q4.

But the latest Tankan survey showed that capacity utilisation in non-manufacturing actually rose in Q4 even as consumption fell. So capacity utilisation across the whole economy may only have fallen marginally, the report added.

Similarly, with the employment rate climbing to a fresh high, there is no sign of slack emerging in the labour market, which is the other factor that feeds into the Bank’s output gap estimate.

Looking ahead, the labour market is expected to loosen a little: the unemployment rate is likely to rise to 2.7 percent by the end of this year. But the rebound in the global manufacturing PMI since last July suggests that the manufacturing sector will soon turn a corner.

"All told, we think that the Bank’s output gap measure will fall a bit but continue to show capacity shortages throughout 2020. In these circumstances, the Bank of Japan will leave policy settings unchanged," Capital Economics further commented in the report.