Since his party’s victory in Japan’s recent lower-house elections, new Prime Minister Shinzo Abe has clearly stressed the importance of economic growth – a complete change from the economic policies of the Democratic Party of Japan. The Liberal Democratic Party is showing a strong preference toward using aggressive monetary easing and increased public spending to revive the economy and overcome deflation. Newly appointed Bank of Japan (BOJ) Governor Haruhiko Kuroda, who worked in the Ministry of Finance in early 2000 and intervened in the currency market, has a market-oriented background and supports bold action to fight deflation.
In April, at the first policy board meeting under the new leadership, the BOJ announced a new and simpler framework for fighting deflation. Pledging to achieve its price-stability target of 2% in a time horizon of two years, the bank decided to double the monetary base. The BOJ also extended the average maturity of Japan's government bonds, purchasing bonds with maturities from three to seven years, and announced its intent to make more purchases of exchange-traded funds and real estate investment trusts.
The swift moves clearly impressed the market, and the new governor succeeded in showing that the new BOJ is different. Although we expect the BOJ to monitor progress of the new easing program for the time being, the policies leave the door open for additional action. If the 2% inflation target does not move closer, further easing measures are possible.
As for the yen (JPY), it has depreciated significantly since last November when the ex-prime minister announced that he would dissolve Japan’s former prime minister. In 2008, the yen began to appreciate significantly against the euro and US dollar due to their radical balance-sheet expansion and quantitative easing by central banks; this exacerbated deflation in Japan and weighed heavily on the Japan's economy. But from now on, the BOJ will expand its balance sheet aggressively and the JPY will likely depreciate in the longer term. In addition, Japan’s trade balance has run a deficit since the Great East Japan earthquake, and this situation is not likely to change soon. Even after the recent move, the yen is still well above pre-2008 levels, which indicates significant room for further depreciation.
Corporate earnings in Japan are expected to bottom out in the 2012 fiscal year, which ended 31 March 2013, and should gain momentum in 2013. Resumed demand from the US and China should provide a positive impact on Japanese companies. In addition, Japanese exporters – such as automobile, machinery, technologies and materials – had previously lost share in the global market as JPY appreciation resulted in decreased competitiveness levels in these industries. But the yen’s depreciation may make these exporters more competitive and may help them gain market share, especially versus Asian competitors. As for domestic demand in Japan, recent equity market and property price appreciation should stimulate private consumption. In fact, department store and luxury item sales had already shown strong growth, and the demand in housing is increasing partly due to inflationary expectations. In addition, the government will increase public spending for preparations for natural disasters, which will push up Japan’s economic activity in 2013.
The BOJ’s policy is the key to the equity market, and its effect should be positive as they keep an aggressive stance until inflation reaches the 2% target. Longer term, wage increases will be needed to overcome deflation and revive the economy. Uncertainty remains, but government policy and the economy look to be moving in the right direction.