Shrinking spare capacity no reason for complacency

Japan’s GDP expanded by 1.0% in 2016, which is a touch faster than the economy’s sustainable rate. We forecast a similar increase in 2017 so spare capacity should continue to decline. Helped by the tailwind from a weaker yen, we expect inflation to rebound to 1% this year. However, this is no reason for complacency. The tight labour market has yet to result in a visible acceleration in wage growth, and inflation expectations remain weaker than before the launch of QQE. The upshot is that the Bank of Japan will have to maintain very accommodative policy settings for a prolonged period.