On 23 July Japanese government bonds, thought to be relative safe assets, were bought on the back of increased risk aversion activity by investors, as the yield on long-term Japanese government bonds (JGBs) temporarily dropped to 0.72% – their lowest level in roughly nine years, since the first half of 2003.
QE is almost a tradition
In addition to interest rate levels, similarities exist between this current development and the year 2003, when yields on long-term government bonds hit historic lows, including the fact that Japanese stocks are now increasingly undervalued and the Bank of Japan (BoJ) has again adopted a quantitative monetary easing policy.
In 2003, in order to prop up the economy the BoJ continued to pump large amounts of money into the market, up until it ceased with its quantitative easing policy in March 2006.
After that, a gradual shift in funds took place from safe assets to risk assets as the domestic economy recovered as a result of the effects of the monetary easing. Although government bonds had been sold by investors, stock prices began to appreciate.
At present, the BoJ is injecting the market with considerable funds in an effort to avoid deflation, beginning with the supply of cash in response to the Great East Japan Earthquake.
The situation still differs from 2003 as structural problems, like non-performing bank loans, weighed heavily on the Japanese economy at that time, but now many concerns over external factors dominate the financial environment, such as the worsening European debt crisis and the slowdown in overseas economies.
Risky assets are the way forward
Nonetheless, it is expected that the monetary easing policy will have an effect on boosting the Japanese economy, leading to a return to investment in risk assets.
In a bill passed by the House of Representatives on 26 June, clauses stipulated that in raising the rate of consumption tax, comprehensive measures and other necessary steps be taken in an effort to ensure desirable economic growth as quickly as possible, with the aim of averaging 3% nominal GDP growth and 2% real GDP growth between 2011 and 2020.
Going by these clauses, it seems that the government wishes to increase the consumption tax rate as smoothly as possible.
Meanwhile, it is likely that further pressure will applied on the BoJ to uphold an accommodative monetary policy. In February this year, when Japan’s central bank announced additional financial easing, stock prices climbed strongly in line with weakening Japanese yen.
Coupled with the debt crisis in Europe, investors will need to keep an eye on local developments and closely monitor any changes in the market.
Sonoko Seo is a senior manager of the product information deaprtment at Nikko Asset Management
