Japan's north-east coast will take years to recover from the devastation inflicted by the earthquake and tsunami, as whole towns have been wiped out and infrastructure has been damaged severely. However, the three worst-affected prefectures, Miyagi, Fukushima and Iwate, account for less than 4% of Japan's GDP. Moreover, most natural disasters have a net positive impact on GDP growth as the initial drop in output is offset by the reconstruction boom that follows. Thus, despite the enormous scale of the human tragedy, the earthquake and tsunami have not changed fundamentally our forecast for the Japanese economy. In the short term the natural disasters and a failure to control the nuclear situation will have a negative impact on the economy. Indeed, the loss of consumer and business confidence owing to concerns that the problems at the nuclear reactors could yet worsen has prompted us to revise down our GDP growth forecast for 2011 to 1%, from 1.4% previously. However, once under way, reconstruction efforts will boost the economy, and we have therefore made an upward revision to our 2012 growth forecast, to 2.1%, from 1.4% previously.

Although our GDP growth forecast for 2011-12 on an annual basis has not been greatly affected by the earthquake and tsunami, our quarterly growth profile now looks significantly different. As there were only a few weeks left in the first quarter of 2011 when the disaster struck, the main negative impact will show up in the second quarter, when GDP is expected to fall quarter on quarter. However, this will prove to be a temporary setback, as the positive impact of reconstruction will boost GDP growth in the second half of 2011 beyond what we previously expected. Reconstruction will be driven by higher government expenditure and private residential investment; private consumption growth, by contrast, will remain weak. The earthquake and tsunami will boost imports at the expense of exports, so that net exports will make only a minor contribution to GDP growth in 2011-12.

The most important caveat to this forecast is our assumption that the nuclear crisis unfolding at the Fukushima Daiichi nuclear plant will not lead to widespread radioactive contamination. Such an event would cause grave and lasting damage to large tracts of land in north-eastern Japan, leaving them uninhabitable for many years. Even something more limited in scope-further radiation in soil and water to levels sufficient to discourage people and firms from rebuilding in those areas-could permanently reduce Japanese wealth, productive capacity and growth potential. This would transform the human tragedy that has already occurred into a long-term economic injury that lowers living standards. Already, there are signs that consumer sentiment and business confidence are suffering amid fears relating to the nuclear crisis, and an extended period of uncertainty over the issue represents a major risk to our 2011 growth forecast.

Unfavourable demographic factors, together with Japan's difficult fiscal situation and persistent deflationary pressures, suggest that the economy will be stuck in the slow lane, with real GDP growth averaging only 1.5% a year in 2012­15. Sluggish wage growth and the probability of higher consumption taxes will depress consumer sentiment in 2011-15, with private consumption forecast to increase at an average rate of just 0.9% a year. Growth in government consumption will be boosted in 2011-12 by relief and reconstruction work but will then fall back in 2013-15, averaging 1.1% a year over the next five years. Investment growth will also be boosted in 2012 by reconstruction, but overall excess capacity in the economy will limit investment growth to an average annual rate of 1.6% in 2011-15. Notwithstanding the impact in the second quarter of 2011 on external trade owing to damage to ports and the loss of economic output owing to power and water outages, long-term trends will remain unchanged. On balance, exports will continue to be underpinned by Japanese companies' operations in fast-growing economies, such as China. We expect exports to grow by 5.7% a year on average in 2011-15, while imports will expand at much the same rate.

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