JPY strengthens after planned sales tax hike in Japan is delayed
The Japanese yen (JPY) strengthened by about 70 pips to 109.80 after Japan Prime Minister Abe announced that he would delay the planned sales tax increase in April 2017 by two and a half years to 2019. He also said that Japan will proceed with structural reforms and fiscal stimulus to achieve strong economic growth. The prospect of more fiscal stimulus has raised market expectations that the Bank of Japan (BoJ) may delay increasing monetary stimulus anytime soon. We acknowledge that as Japan is experiencing a liquidity trap, fiscal spending will have a larger multiplier effect on economic growth. However it is also worth noting that the BoJ has factored in that economic growth in the current fiscal year will be boosted by about 0.4pp due to front loading of consumption ahead of planned sales tax hike in April 2017. Hence it remains highly uncertain if the size of fiscal stimulus will compensate the lower contribution from domestic consumption in the absence of sales tax increase. Earlier today, the Ministry of Finance reported that company profits in the first quarter contracted at a faster pace of 9.3% yoy, compared to 1.7% contraction in the last quarter of 2015. The strength in the JPY has no doubt played a part in the dismal profits numbers. Weak profits growth will remain a headwind to investment plans and wage growth. More importantly, inflation ex food and energy and effects of sales tax has peaked in December 2015, declining from 1.3% to 0.9% in April 2016. The JPY inflation swap (market based inflation expectations) has also declined substantially since the beginning of this year. In conclusion, we maintain our view that there is a case for the BoJ to increase monetary stimulus later this year to achieve their 2% inflation target.