Fri. Jul 1st, 2022

Surging energy costs, supply chain disruption and Russia’s invasion of Ukraine have knocked Japanese business confidence lower for the first time since the outbreak of the Covid-19 pandemic two years ago, an important survey has shown.

The latest quarterly survey by the Bank of Japan revealed that sentiment among big Japanese manufacturers fell for the first time since the April-June 2020 quarter, marking a turning point for Asia’s second-biggest economy, where businesses had previously been cautiously optimistic about an end to the pandemic.

But the survey, which was conducted between late February and late March, also showed the large disconnect between the foreign exchange assumptions made by corporate Japan and the recent reality of a market where the yen plummeted this week to a seven-year low.

The BoJ’s Tankan survey of business confidence, released on Friday, dropped to a level of plus 14 in the first quarter from plus 17 in the previous three months, compared to a median market forecast of plus 12.

The Tankan survey, one of the most comprehensive economic indicators in Japan, polls big companies about whether business conditions are “favorable” or “unfavorable”. The latter tally is subtracted from the former to generate a composite reading of between minus 100 and plus 100, with figures above zero indicating positive business sentiment and those below zero negative sentiment.

While sectors such as production machinery sustained the index in the quarter to March, pulp and paper and other industries worsened. Automobile production fell after the suspension of plant operations following the resurgence of the Omicron variant.

Big manufacturers expected conditions to deteriorate further in the coming three months, with a predicted index of plus 9.

The downward trend was echoed by large non-manufacturers, which slipped in the survey from plus 10 to plus 9. Among these companies, accommodation and food services expect a significant improvement from the lifting of quasi-state of emergency Covid-19 measures, but the sector sub-index is expected to remain in negative territory in the next three months, according to the BoJ.

The survey found that companies were under pressure from the suppression of economic activity because of the Omicron wave, unstable financial markets triggered by the war in Ukraine and subsequent sanctions against Moscow and higher costs owing to rising energy prices and the weakening yen.

“The survey was intended to assess the depth of the downside risks surrounding Japan’s economy, but it was not as bad as previously expected,” said Takuji Aida, chief economist at Okasan Securities.

While the yen’s depreciation may put additional pressure on profits because of rising procurement costs, Aida said that the weaker currency was acting as a tailwind for the Japanese economy by raising export prices, which would somewhat mitigate the negative impact of the war in Europe

The survey found the average predicted exchange rate for the fiscal year starting in April stood at ¥ 111.93 against the US dollar, marking a large contrast with recent days. On Friday morning, the yen traded at about ¥ 122 to the dollar after hitting a seven-year low of ¥ 125.1 this week.

The better-than-consensus survey result should have a slightly positive impact on equities, but “foreign factors are much more important influences today”, said John Vail, Nikko Asset Management chief global strategist.

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