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Japan skids back into recession in 3Q

Japanese Prime Minister Shinzo Abe faces looming pension problems as aging population grows.Photograph by Christophe Archambault — AFP/Getty Images

Japan’s economy shrunk again in the third quarter, casting further doubt over the strategy of Prime Minister Shinzo Abe’s reflationary shock therapy and making it likelier than ever that he will call snap elections.

The news was a huge shock to financial markets, which had expected a modest bounce after the savage drop in the second quarter caused by a sharp increase in the country’s sales tax. That tax hike, coupled with a massive monetary stimulus from the Bank of Japan, were two of the three main pillars of a policy aimed to jolt Japan out of a nearly 20-year struggle with deflation.

Government data said gross domestic product shrunk 0.4% on the quarter and was down 1.6% from a year earlier. Economists had expected a quarterly rise of 0.5% and a 2.1% annual growth rate.

Marc Ostwald, an economist with ADM ISI in London, said the figures left the so-called “Abenomics” strategy “in tatters.”

In a note to clients, Ostwald said Abe is now almost certain to postpone the second stage of the planned sales tax hike, originally scheduled for next October, and call new elections “as early as this week.”

The dollar surged to a new seven-year high of over 117 yen on the news, although the Japanese currency regained some of its losses later. Both Japanese and, to a lesser extent, European stocks fell as the figures revived fears about the health of the global economy.

There were, admittedly, some signs that the data might not be as awful as they seemed at first glance. Most of the shortfall was due to a big drop in corporate inventories, suggesting that companies had held off from producing in the third quarter, uncertain about how long it would take the domestic economy to get over the shock of the first sales tax increase.

Inventories can be a volatile element in GDP calculations, especially if a short-term “wait-and-see” approach ends up leaving companies short of what they need if demand picks up. Most recent indicators suggest that the flow of new orders to Japanese businesses has been pretty healthy in recent months.