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Chief economist update: Japan on the mend but BOJ, Abe not taking any chances

Japanese Prime Minister Shinzo Abe's lifting of the state of emergency in the country on May 25 has been rewarded with encouraging indications of recovery in the economy.

This is highlighted by the improvement in the au Jibun Bank Japan PMI surveys. Preliminary estimates show the composite index rising to a reading of 37.9 in June from May's final reading of 27.8 and the all-time low reading of 25.8 recorded in April. The flash services PMI jumped to 42.3 in June from 26.5 in the previous month - an indication of the improvement in domestic activity -- but the manufacturing PMI fell to a preliminary score of 37.8 from 38.4 in May - as most international borders remain closed.

So far so good. The positive spin is that these green shoots could provide positive momentum in economic activity going forward. Then again, the increasing risk of a second wave - in Beijing, in Victoria and even New Zealand - could force the government to declare a state of emergency part deux.

Not to mention, despite the improvement in Japan's purchasing managers' surveys, both the services and manufacturing PMI remain in contraction (below 50).

This would keep the Bank of Japan (BOJ) from achieving its 2% inflation target. Latest stats show that Japanese headline CPI inflation remained barely above zero (0.1%) in the year to May while core inflation lingered in deflation (-0.2%) over the same period.

Thus, while both the Bank of Japan (BOJ) and the Abe government are optimistic about the economic outlook, they're not leaving this to hope.

While it kept interest rate settings unchanged at its 16 June monetary policy meeting, the BOJ increased the size of its lending packages to around US$1 trillion from May's US$700 billion.

The Japanese government was also waxing optimistic - noting in its June report that although the economy presently remains in an extremely severe situation, it's stabilising (from May's assessment of rapid deterioration).

Nevertheless, after "having rolled out a combined $2.2 trillion in two stimulus packages to avert a deeper recession", according to Reuters, Japan's former economy minister and the head of the Liberal Democratic Party's (LDP) tax panel, Akira Amari, had recently been quoted announcing that: "The government is expected to compile a full-scale economic stimulus package to support growth this fall as the previous two were to protect lives, jobs and firms. In that sense, comprehensive steps to boost the economy are not in place yet."

Both the government and the central bank have to stand ready to provide more support if they are to avoid (or at least mitigate) the OECD's latest prediction for a 6.0% contraction in GDP growth this year (assuming no second wave) to a fall of 7.3% (under a double-hit scenario).

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