Escape from zero The Q3 CY16 GDP print confirms our view that Japan has at last emerged from the de facto zero-growth trap of the past few years. Growth accelerated to an above- consensus 2.2% q-o-q saar, after a 0.7% rise in Q2 CY16 and 2.1% rise in Q1 CY16. We expect a moderation in Q4 CY16, but underlying growth will remain firmly in the 1.0- 1.5% range. We are currently tracking CY2016 growth of 0.7%, a modest improvement from 0.6% in CY2015, though the switch to a new GDP standard’ next month raises uncertainty around our forecasts. Upturn in exports to be sustained through Q3 CY17 The recent recovery has been driven by a fading consumption tax shock and stronger exports. The downturn in the global industrial cycle in 2014-16 hurt Japan, but manufacturing activity bottomed out early this year and is now modestly expanding (Chart 2). The OECD leading indicator continues to signal a synchronized pick-up in global growth (Chart 3). The domestic inventory cycle also points to production gains ahead (Chart 4). For Japanese exporters, the improvement in demand has been most visible for Europe (Chart 5). US and Chinese demand will likely follow, though the mainland’s structural shift to services implies only a modest acceleration. We expect the current up-cycle in global exports to be sustained through Q3 CY17 — possibly longer depending on developments in the US (more on this later). The combination of stronger external demand and a weaker currency should shore up business confidence, especially among manufacturers, and lay the foundations of Japan’s recovery. Chart 2: Industrial activity has bottomed out Chart 3: OECD leading indicator points to modest global expansion Index 2010=100 3mma sa S at 110 6 IN 30 105 4 N N [> ~ AN 10 2 ROA : 100 > LN \\ Wa el an 95 2 \/ -30 90 4 85 6 -50 2010 2014 2012 -2013««2014.«2045 (2016 «2017 2000 2002 2004 2006 2008 2010 2012 2014 2016 == OECD global leading indicator, %YoY (LHS) ——IP Real exports === Japan real exports, %YoY (RHS