The Bank of Japan seems to have underestimated the drag on domestic demand from October’s sales tax hike. But the global outlook has improved and the government’s fiscal stimulus announcement has given policymakers a further reason to sit on their hands.

The Bank to keep policy settings unchanged this week and in the foreseeable future, according to the latest research report from Capital Economics.

Many analysts had expected the Bank to cut its short-term policy rate deeper into negative territory at the October meeting.

However, while it kept policy settings unchanged, the Bank did underline its willingness to ease policy in future, noting that it “expects short- and long-term interest rates to remain at their present or lower levels as long as it is necessary to pay close attention to the possibility that the momentum toward achieving the price stability target will be lost”.

On balance, the domestic picture has worsened. Admittedly, the 0.4 percent q/q quarterly rise in GDP in the third quarter was solid enough. And the relatively muted 0.5 percent q/q increase in private consumption in Q3 seems to corroborate the Bank’s assessment that households brought forward fewer purchases ahead of the sales tax hike on October 1 than they did ahead of previous tax hikes, the report added.

However, the small rise in consumption in Q3 didn’t prevent a slump in household spending after the tax hike. The Bank’s own consumption activity index fell by nearly as much in October as it did after 2014’s sales tax hike. The Bank therefore is no longer able to argue that the impact of the tax hike is “marginal”.

"We still expect consumer spending to fall by much less in the fourth quarter (1.7 percent q/q) than it did in the quarter after the 2014 hike (4.8 percent). But even this would pull GDP down by around 1 percent q/q," Capital Economics commented in the report.

Another worrying sign is that the Bank’s Q4 Tankan survey showed that business confidence weakened to a six-year low in Q4. And a fourth consecutive fall in machinery orders in October suggests that business investment will soon start to weaken following the 1.8 percent q/q jump in Q3.

What’s more, the 4.5 percent m/m plunge in industrial production in October marked the largest fall since the Great East Japan Earthquake in 2011. As a result, the Bank will reportedly downgrade its assessment of industrial output from “more or less flat” to “weakening”.

"Indeed, the Bank’s forecast of a 0.6 percent rise in real GDP in the fiscal year that ends in March looks increasingly optimistic. Our forecast is a 0.2 percent fall," the report further commented.