(Public Policy and Economic Research Group)

Executive Summary

Global economy to grow steadily despite present slowdown

The world’s financial markets have wavered considerably since the end of February 2007 as share prices have plunged and the yen has rapidly appreciated. Aside from concerns about a downturn in the U.S., the main reason for this is the unraveling of yen carry trades (i.e., yen borrowing at low interest rates to invest in high-interest foreign currencies). Although there are concerns that this could impact on the real economy, the real economy itself is growing strongly, and there is no sign of its having an immediate impact. With an acceleration in growth also presently possible, the global economy looks set to grow steadily for the time being. It needs to be borne in mind, however, that the correction of the global liquidity glut caused by deflationary economies will have definite repercussions. Owing principally to (1) slowing production activity and (2) continued adjustment in the housing market, the U.S. economy may decelerate more rapidly than generally envisaged from now to the first half of 2007. The continued healthy state of the employment and income environment will ensure that this does not develop into a recession, and growth is projected to pick up again from the second half of 2007. Hit by the slowdown in the U.S., the real GDP growth of the global economy will gradually slow to 3.9% in 2006 and 3.4% in 2007, though the underlying tone will stay firm and growth is projected to begin to accelerate again to 3.6% in 2008 (Fig. 1). Continued strong growth in China and the rest of the Asia region and steady growth in the EU will underpin global growth.

Japanese economy shakes off mild adjustment to continue modest growth

The Japanese economy is presently enjoying strong growth driven mainly by domestic demand. Real GDP grew 2.3% from a year earlier in the fourth quarter of 2006, and 5.5% compared with the previous quarter, as the economy notched up its 18th consecutive quarter of year-on-year growth. With the economy continuing to grow, the Bank of Japan (BOJ) raised the target unsecured overnight call rate from 0.25% to 0.50% on February 21, 2007.

Although the Japanese economy is presently growing vigorously, a combination of (1) a lull in exports due to the slowdown of the global economy, (2) slowing production due to slackening growth in foreign demand and investment adjustment affecting mainly IT and digital products, and (3) slowing growth in corporate earnings owing to rising personnel costs heading into the first half of fiscal 2007 mean that the base scenario envisaging slowing growth remains unchanged from the previous forecast. In the second half of fiscal 2007, the global economy will emerge from the slowdown, with the U.S. leading the way, and so recession will be avoided and economic growth is projected to continue. In the latter half of fiscal 2008, domestic demand is expected to surge due to a spike in demand ahead of a hike in the consumption tax rate (from 5% to 8% in April 2009). Based on the above, Japan’s real GDP is expected to grow 2.0% in fiscal 2006, 1.8% in fiscal 2007, and 2.7% in fiscal 2008, which represents s slight upward revision from the previous forecast of 1.8% growth in fiscal 2006, 1.5% in fiscal 2007, and 2.9% in fiscal 2008 (Fig. 2) due to the present strong growth in capital investment and other areas of the economy.

World’s monetary policies and financial markets emerge as risk factors alongside residual downside risk

Concerns over the future course of the global economy, such as the possible impact of instability on the financial markets, have increased compared with at the time of the preceding forecast. The economic outlook was already being viewed with caution then, and the base scenario remains unchanged for this forecast. However, the following remain as downside risk factors: (1) a sharp slowdown in the U.S., (2) deepening inventory adjustment affecting IT and digital products, (3) a sharp deterioration in corporate earnings triggered by a resurgence in oil prices, and (4) a decline in share prices caused by concerns about recession in the U.S. and a sudden appreciation of the yen against the U.S. dollar if the problem of the current account deficit flares up again. While the global economy, and the U.S. in particular, is projected to gradually slow for around the next six months or so, adjusting the speed of the slowdown will be tricky. Individual countries’ monetary policies and market adjustments will therefore have to be watched closely as the world steers a tight course between inflation and recession.