On an annualised basis, Japanese GDP grew 3.8% when adjusted for seasonal factors, significantly above the previous estimate of 2.6%.
We expect the Bank of Japan to further its calls for economic reform, as well as introduce tax measures to reduce Japan’s long-term debt levels. We think it’s likely that sales tax will be increased from 5% to 8% this year, and then 10% in two or three years. News that Japan has been awarded the 2020 Olympics should further encourage growth prospects.
The big Asia economies have started the month well, with strong trade data also coming out of China on Monday. Meanwhile, prospects for the US Federal Reserve (Fed) to begin scaling back quantitative easing (QE) this month were dealt a setback on Friday from disappointing US payrolls data.
Gains in US private-sector employment fell short of the 180,000 new jobs per month that is seen by many economists as needed to justify scaling back QE. We have been of the view that the Fed will adopt a light touch, ensuring a continuing recovery.
Equities – reform momentum for Japan shares
Japan’s Economy Minister Akira Amari recently claimed widespread support for the government’s plans to increase the sales tax in conjunction with an offsetting reduction in corporate tax rates, suggesting these reforms will go ahead. We view this as a long-term positive for Japanese equities, while also reinforcing our positive outlook over the rest of this year and into the next.
Data continues to show signs of improvement in confidence and activity since the Bank of Japan announced very aggressive plans to expand its asset purchases over the next two years. Key inflation measures have also picked up significantly in recent months, providing further evidence that efforts to reflate the economy are starting to work.
Bonds – same vote, different result for bunds & gilts
Both the European Central Bank (ECB) and Bank of England (BoE) voted for no change in policy at their respective meetings last week, but their paths towards economic health are increasingly different.
Sterling and implied yields on UK interest-rate futures are rising on the basis that the rapid pace of recovery seen in a broad range of recent indicators will translate into either rising employment or inflation. Many in the market now see a rate hike as early as the first quarter of 2015, but we remain in the ‘rates low for long’ camp. The reaction to the ECB’s policy announcement has been the opposite – pushing the euro and implied yields on eurozone interest-rate futures down.
The ECB is even more dovish. But a less robust recovery means that a dovish ECB is less prone to a policy error leading to rising inflation. This makes German bunds more attractive than UK gilts, although we see both underperforming their respective equity markets.
Currencies – euro to drift lower on ‘wings of a dove’
Despite an improved outlook for the eurozone, ECB officials have reiterated their commitment to dovish policy (keeping it accommodative) for an extended period. That contrasts with the Fed’s plans to scale back policy support in coming months, and this policy divergence should drive moderate euro weakness versus the dollar.
In the second quarter the eurozone economy grew for the first time in nearly two years, and we expect this trend to continue in the months ahead. Concerns over systemic risks in the eurozone also continue to ease, despite slow progress on structural reforms. However, further recovery remains dependent on easy monetary conditions, which should keep the euro under downward pressure.
