The slowdown in the previous quarter was widely attributed to a fall in demand for goods and services following a hike in consumption tax (VAT) to 8% from 5%. The slowdown in the three months to September looks to have been exacerbated by businesses cutting back spending.
This is the fourth time Japan has slipped into recession since the financial crisis. This latest setback will fuel speculation Prime Minister Abe will postpone by around 18 months a further rise in consumption tax to 10% from 8% (due to take effect next October). It has also been suggested he might call a snap election, though the timing would be questionable as his popularity is currently at a low point.
It is important to remember this is just an initial estimate based on a limited amount of data. The government had previously indicated it would wait until the second estimate of third quarter growth was released on 08 December before making a decision over consumption tax. Mr Abe is expected to confirm tomorrow whether he will defer the consumption tax rise and call an early election (possibly on 14 December).
Following the news the yen weakened against the US dollar to its lowest level for around seven years and the Nikkei 225 closed down almost 3%. The stock market and currency could remain volatile until Mr Abe confirms his intentions. There is of course the prospect of further economic stimulus as well.
Investors should look through the short term economic noise and focus on the long term prospects. Our analysis continues to suggest Japan is one of the cheapest major stock markets in the world and investors should use setbacks such as these to top up their exposure.