Yen Weakness Returns, Nikkei Gains

As yen weakness returns and the Nikkei regains its lofty gains, will the Bank of Japan succeed in turning its expansionary monetary policy into rising inflation?

Last April, the BoJ convinced the world about its reflationary plans by redefining the definition of price stability towards 2.0% y/y, as well as doubling its monetary base from ¥135 trn to ¥270 trn within two years. This would be done by raising the average maturity of Japanese Govt Bonds to seven years from three years—all via a monthly expansion of its balance sheet to the tune of 1.1% of GDP—compared to 0.5% of GDP by the Fed ($85 bn).

The planned expansion of monetary policy in April, however, will be joined by tightening fiscal policy via a consumption tax hike from 5% to 8%. It would be the first such tax hike since 1997, when the economy plunged into a decade long contraction. But this time, PM Abe isn’t worried. GDP rose by an annualized rate of 4% in H1, more than double the rate of the US. GDP growth in Q2 and Q3 fared 0.9% q/q and 0.3% q/q respectively.

Some fiscal easing is also planned to offset the sales tax hike, such as expanded tax relief for homebuyers, cash disbursements for low-income earners and the repeal of surcharges on corporate income tax. Balancing between the commitment to halve Japan’s budget deficit and stimulating spending remains a key challenge for PM Abe.

Wages Key to Inflation
But for FX traders, inflation growth remains a major focal point. Without continued progress in consumer prices, it would be difficult to for yen weakness to remain. The 1.1% y/y CPI attained in October was the highest since November 2008. Inflation has remained above its 3-month average since the last 6 months. A vital requirement to keep it going is wage growth. Japanese companies (services and manufacturers) show mixed signals over compensation. Increased bonuses have been prevalent over the last 6 months following the 150% jump in Japanese equities. But translating compensation into persistent wage growth has yet to be seen. Worries with job security and cultural considerations continue to act as a detriment. Worker’s real household income fell to -1.3% y/y in October, the lowest in more than 2 years. As long corporate retained earnings show no change of structure and labour remains sky over their demands, little will be changed and neither will the spending-deflation circle.

For the Nikkei-225, the 3rd attempt to cross its 17-year trendline above 15,800 may not materialize immediately, but prospects for a breakout could emerge as we approach the 2013-14 fiscal year in April. Support is expected to hold at 14,500 for now.

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