Japans production likely to strengthen ahead

In July's monthly economic report, the japan government revised down its overall assessment on production from "production is showing weakness in some areas but overall is improving " to "production remains flat". As producers have been cautious regarding inventory investment in the past, the level of inventories is not a major problem. The production trend in 2015 depends on how strongly exports pick up on the back of a US economic recovery, and also on how the Chinese economy can avoid an economic downturn. In addition, domestic demand should become firm thanks to aggregate wage demand. Therefore, a gradual strengthening in production trend momentum is expected, argues Societe Generale. 

Once companies start to forecast a continuous increase in prices and costs, they will probably shift their stance from reducing inventories to increasing inventory investment regardless of any further improvement in inventory management. In addition, in the event of full employment and with a fur ther rise in costs due to yen depreciation becoming a large risk, it would not be rational for companies to reduce inventories. This is because it would be more profitable for companies to increase inventory in the current (cheaper) cost environment. 

"Recent real GDP data shows that change in inventories is still negative, but we expect it to turn positive. As corporate growth and expected inflation are both rising, in our view, the attitude to inventories is gradually shifting from one of inventory adjustment to one of inventory investment. Therefore, production is likely to strengthen ahead", said Societe Generale in a note to its clint.