The announcement by the BoJ to extend its asset purchase programme by a further ¥10trn did not meet with the same enthusiasm as the last round of stimulus. Investors will take some heart from the fact that an additional round of bond buying coincides with higher growth and inflation projections for 2012 and 2013.
Deflationary cycle
As such, this may signal some commitment from the BoJ to break Japan’s deflationary spiral and bolster the domestic economy. Yet headwinds will remain. On the positive side, the additional ¥10trn of government bond purchases came with a commitment to lengthen the tenor of bonds bought out to three years.
Arguably the market expected such a move, along with increases in risk asset purchase pools in equities and real estate securities at a later stage. Yet stimulus alone by policymakers has proved to be ineffective.
The true catalyst for breaking the trend of yen resilience involves both loose monetary policy (first steps made) and tighter fiscal policy, delivered, for instance, via an increase in the consumption sales tax and shrinking government spending. That strategy remains dormant under Prime Minister Noda. Even if political action were to materialise, constraints at the global level may temper the pace of any recovery in the Japanese economy.
With a 1.2% decline in retail sales over the month of March, the probability of any rise in income and consumption looks quite low. On a more positive note, March export data, stripping out seasonal adjustments, rose 1.2%, a sign that the export cycle has bottomed and that net exports will contribute positively to first quarter GDP (released on 17 May).
Nevertheless, exports to the European Union (accounting for around 10% of total export value) remain depressed.
Despite headline inflation figures showing modest year-on-year price gains of 0.5%, this was principally a function of elevated oil prices, the extent of which may abate in coming months. National consumer price index inflation excluding food and energy fell 0.5% compared to one year earlier, showing the nominal expansion of the economy is still disappointing. Overall, the BoJ is still some way from its 1% inflation target and nominal GDP growth remains low.
Slow recovery
Although preliminary industrial production figures for March rose by 1% (below consensus of a 2.3% gain), production targets were missed by a substantial amount. We believe that this heralds a recovery trend but at a slower rate than previously forecast.
Many market pundits are itching to buy the story of a rebound in Japanese assets, especially domestic equities. Valuations are still attractive against their historic averages and corporate earnings expectations are being upgraded.
The fate of the stock market is still linked heavily to that of the yen, we feel. The correlation between yen weakness and Topix performance is also high at present (+0.8, more than one standard deviation away from 20-year average of 0.07). There was little reaction to the policy announcement in the currency market with dollar/yen settling around the ¥80.80 level (many Japanese corporates are targeting ¥80 in their 2012 assumptions for profitability).
The balance of risk is that yen weakens further in the short run as the market anticipates more action from the central bank, backing a rise in the stock market. Yet if the US weakens in the second half and the Fed engages in QE3, the BoJ may have to step up its easing cycle in order to prevent excessive yen strength. More interesting, perhaps, is yen weakness against local Asian currencies, especially those that typically use Japanese products in their own export cycles (Korea, Taiwan). In these nations some export resilience persists.
To get a really big sustained move lower in the value of the yen would call for real progress around fiscal consolidation – something that looks implausible for now.
