Bank of Japan : Outlook for Economic Activity and Prices (April 2021, full text)

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Wednesday, April 28, 2021.

Outlook for Economic Activity and Prices

April 2021

(English translation prepared by the Bank's staff based on the Japanese original)

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Secretariat of the Policy Board, Bank of Japan

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Outlook for Economic Activity and Prices (April 2021)

The Bank's View1

Summary

• Although the level of Japan's economic activity, mainly in the face-to-face services sector, is expected to be lower than that prior to the pandemic for the time being, the economy is likely to recover, with the impact of the novel coronavirus (COVID-19) waning gradually and supported by an increase in external demand, accommodative financial conditions, and the government's economic measures. Thereafter, as the impact subsides, it is projected to continue growing with a virtuous cycle from income to spending intensifying.
• The year-on-year rate of change in the consumer price index (CPI, all items less fresh food) is likely to be slightly negative for the time being, mainly affected by COVID-19 and a reduction in mobile phone charges. Thereafter, it is expected to turn positive and then increase gradually, mainly on the back of economic activity continuing to improve and the effects of the reduction in mobile phone charges dissipating.
• Comparing the projections through fiscal 2022 with those presented in the previous Outlook for Economic Activity and Prices (Outlook Report), the projected growth rates are higher, mainly for fiscal 2022, on the back of stronger domestic and external demand. The projected rate of increase in the CPI for fiscal 2021 is lower due to the effects of the reduction in mobile phone charges, but that for fiscal 2022 is more or less unchanged.
• The outlook for economic activity and prices provided in this Outlook Report is highly unclear, since it could change depending on the consequences of COVID-19 and their impact on domestic and overseas economies. The outlook is based on the assumption that the impact of COVID-19 will wane gradually and then almost subside in the middle of the projection period. It also is based on the premises that, while the impact remains, firms' and households' medium- to long-term growth expectations will not decline substantially and the smooth functioning of financial intermediation will be ensured with financial system stability being maintained. However, the assumption and premises entail high uncertainties.
• With regard to the risk balance, risks to economic activity are skewed to the downside for the time being, mainly due to the impact of COVID-19, but are generally balanced for the middle of the projection period onward. Risks to prices are skewed to the downside.

1 "The Bank's View" was decided by the Policy Board at the Monetary Policy Meeting held on April 26 and 27, 2021.

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I. Current Situation of Economic Activity and Prices in Japan

Japan's economy has picked up as a trend, although it has remained in a severe situation due to the impact of COVID-19 at home and abroad. Overseas economies have recovered on the whole, albeit with variation across countries and regions. In this situation, exports and industrial production have continued to increase. In addition, corporate profits and business sentiment have improved on the whole. Business fixed investment has picked up, although weakness has been seen in some industries. The employment and income situation has remained weak due to the impact of COVID-19. A pick-up in private consumption has paused due to increased downward pressure on consumption of services, such as eating and drinking as well as accommodations. Housing investment has declined moderately. Public investment has continued to increase moderately. Financial conditions have been accommodative on the whole, although weakness in firms' financial positions has been seen. On the price front, the year-on-year rate of change in the CPI (all items less fresh food, and the same hereafter) has been slightly negative, mainly affected by COVID-19 and the past decline in crude oil prices. Meanwhile, inflation expectations have been more or less unchanged.

1. Baseline Scenario of the Outlook for Economic Activity and Prices in Japan A. Baseline Scenario of the Outlook for Economic Activity

Japan's economy is likely to recover, although the level of economic activity, mainly in the face-to-face services sector, is expected to be lower than that prior to the pandemic for the time being. That is, with the impact of COVID-19 waning gradually and the economy being supported by an increase in external demand, accommodative financial conditions, and the government's economic measures, a virtuous cycle from income to spending is expected to operate. Thereafter, as the impact subsides, the economy is projected to continue growing with the virtuous cycle intensifying.

This baseline scenario is based on the assumption that, while taking preventive measures against COVID-19 and improving economic activity simultaneously, the impact of COVID-19 will wane gradually and then almost subside in the middle of the projection period, due mainly to progress with vaccinations. The outlook also is based on the premises that, in Japan, while the impact of COVID-19 remains, firms' and households' medium- to long-term growth expectations will not decline substantially and the smooth functioning of financial intermediation will be ensured with financial system stability being maintained.

Looking at the outlook for economic activity based on the assumption and premises in more detail, overseas economies are likely to continue growing, albeit with variation across countries and regions, partly supported by aggressive macroeconomic policies taken mainly in advanced economies. In this situation, although the pace of increase in

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Japan's goods exports is likely to decelerate for the time being, mainly for automobile-related goods, goods exports are projected to continue increasing firmly, supported by a global recovery in business fixed investment and an expansion in digital-related demand. Inbound tourism consumption, which is categorized under services exports, is expected to remain subdued while entry and travel restrictions continue but likely to recover thereafter.

An uptrend in business fixed investment is expected to become clear, mainly for machinery and digital-related investments, with improvement in corporate profits and supported by accommodative financial conditions and the government's economic measures, although construction investment by the face-to-face services sector is projected to remain weak.

Private consumption, mainly of face-to-face services, is likely to remain sluggish, being at a relatively low level for the time being due to the impact of COVID-19, but then it is expected to pick up again with the impact waning gradually and supported also by the government's economic measures. Thereafter, as the impact of COVID-19 subsides, an uptrend in private consumption, including that of face-to-face services, is projected to become evident with employee income improving. Employee income is likely to stop declining, reflecting improvement in corporate profits, and then increase moderately with a time lag following the recovery in domestic and external demand.

Meanwhile, public investment is projected to steadily increase, reflecting progress such as in construction related to restoration and reconstruction following natural disasters, as well as to building national resilience. Thereafter, it is expected to be at a relatively high level. Government consumption is likely to increase clearly for fiscal 2021, mainly reflecting enhancement of the medical treatment system and the testing and vaccination system, but see a lowering in its level thereafter.

B. Baseline Scenario of the Outlook for Prices

The year-on-year rate of change in the CPI is likely to be slightly negative for the time being, mainly affected by COVID-19 and the reduction in mobile phone charges.2 That said, the reduction is a temporary factor, and when its effects are excluded, the year-on-year rate of change in the CPI is expected to be steady. Although weakness in demand amid the situation of COVID-19 is projected to have an impact on prices, firms' price cuts that aim at stimulating demand have not been and are not likely to be observed

2 The CPI forecasts in this Outlook Report are based on the current 2015-base index. The statistics authority that compiles the CPI has announced its plan to rebase the CPI to the base year of 2020 and retroactively revise its figures for the year-on-year rate of change from those for January 2021 onward, both in August 2021. With the rebasing, the reduction in mobile phone charges will have a larger impact than the current index, mainly because the weight of such charges in the CPI will rise. Therefore, the year-on-year rate of increase in the CPI is highly likely to be revised downward for the 2020-base index.

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