In a major blow to Prime Minister Shinzo Abe’s Abenomics, Japan’s economy contracted in the last quarter of 2015. GDP growth shrank by 1.4% on an annualized basis, worse than economists’ expectation of 1.2% in Q4 2015.

This implies that the world’s third-largest economy has contracted in two out of the last three quarters, in the process avoiding a technical recession. The contraction was primarily caused by weak consumption, coupled with low investment in the housing sector. Exports are declining on account of falling demand from China, Japan’s major export market. (Read also, Japan's Strategy to Fix its Deflation Problem.)

Consumer Demand Still Weak

While both the Bank of Japan and the government have adopted expansionary policies for a while now, consumer demand has failed to pick up steam as it declined at an annualized rate of 3.3%, marking its lowest level in the last four years. Stagnant wage growth has led to a decline in consumer spending, but some analysts believe that the warm winter has also played a part.  

Genzo Kimura, an economist at Sumitomo Mitsui Trust said, “The gap between prices and slow wage growth continues to widen, taking away the purchasing power from households in Japan. We are now facing an economic bottleneck.” However, some analysts believe that consumer demand is likely to surge in coming months as consumers anticipate a sales tax increase, which will probably  decline after the hike. Marcel Thieliant of Capital Economics said, “[The rise in consumer spending] should be short-lived, as activity will almost certainly slump once the tax has been raised.”

Positive Business Investment and Trade Data

The weak consumer spending was partially offset by an increase in business investment, which rose at an annualized rate of 5.7%. Genzo Kimura said, “Positive contributions have come from tourism and construction companies involved in infrastructure projects around the 2020 Olympic Games.”

At the same time, international trade also contributed positively to GDP growth. While exports declined at an annualized rate of 3.4% due to a slowdown in China, imports declined at a faster pace amid falling oil and commodity prices. (See also, 3 Economic Challenges Japan Faces in 2016.)

The Bottom Line

Despite GDP numbers indicating contraction in the fourth quarter, Japanese stock markets as measured by Nikkei 225 Index were trading in positive territory, driven by a fall in the yen. On the other hand, the GDP growth rate for the full year of 2015 was 0.4%, slightly up from a flat 2014, which still falls short of Abe’s goal of a $5.3 trillion Japanese economy by 2020.

Many economists believe that economic activity is likely to pick up in coming quarters, especially after the Bank of Japan adopted a negative interest rate policy late last month. According to a poll of 38 economists by the Japan Center of Economic Research, Japan’s GDP will grow at an estimated rate of 1.44% in Q1 2016.