The honeymoon is over for Japan's prime minister, Shinzo Abe.
The financial markets loved it when Abe announced a three-arrow strategy last year for ending his country's two decade struggle with deflation and sluggish growth. Share prices soared and the yen fell after the new government pledged large-scale quantitative easing, higher public spending and structural reform in a package dubbed Abenomics.
But markets were left distinctly underwhelmed on Monday by Japan's latest GDP figures, which showed growth at 2.6% in the year to the second quarter of 2013, down from 3.8% in the 12 months ending in March. The rate of expansion was far weaker than expected and scotched the always rather fanciful hopes that Abe had found a magic bullet for Japan's woes. He hasn't.
Problems have emerged with every bit of the three-quiver policy. Firstly, driving down the value of the yen was supposed to boost the Japanese economy by making life easier for its key export sector. But it has also raised the cost of imports, particularly fuel, at a time when domestic energy production remains hampered by the Fukushima nuclear plant. Dearer energy raises business costs and eats into consumers' real incomes. As some analysts noted, Japan is getting higher inflation as planned, but it is the wrong sort of inflation.
A second problem is that doubts are starting to surface about the government's commitment to structural reform. Japan is an elderly and conservative country where the dynamics of an ageing population make it mightily difficult to raise participation rates in the labour market or reduce subsidies to farmers, even if ministers were prepared to make themselves unpopular.
But the biggest immediate problem for Abe is that the weak growth has raised doubts about whether he will go ahead with the increase in consumption tax next year, designed to show markets that Tokyo is serious about tackling Japan's public debt, currently 240% of GDP. The increase in sales tax from 5% to 8% is chunky and, with a second increase to 10% planned for 2015, clearly has the capacity to derail economic recovery.
Japan has history in this respect, with tentative recoveries in the 1990s aborted due to over-hasty tightening of policy. Ideally, the increase in sales tax should take place at a slower rate over a longer period, which is what one of Abe's advisers suggested on Monday. The question is whether this can be achieved without the government's credibility being shredded. A final decision will be taken next month: the hesitancy adds to the sense that Abenomics is essentially smoke and mirrors.
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