- Recent developments have strengthened our conviction that the BoJ will ease policy this month
- The Brexit vote has led to tighter financial conditions in Japan…
- …resulting from a stronger yen and weaker equity markets
- The inflation outlook is equally concerning
- We think the BoJ will likely ease policy by cutting the policy rate 20bp to -0.3% and raising the amount of its asset purchases to JPY100tn
Japan’s weak economy exacerbated by Brexit
At the time of writing this note, post UK referendum developments are still uncertain. Japan is quite vulnerable given the weak economic indicators and its safe haven status. If financial conditions continue to tighten in Japan as a result of weaker equity markets and a stronger yen, this will likely exacerbate the weakness in Japan’s economic outlook. This is partly the result of sluggishness of investment growth and weak foreign demand. Growth in business investment has been modest, despite the strong corporate profits reported in the past year. Indeed, the improvement in profits does not appear to be seen as a permanent increase in income and firms remain cautious about expanding their costs. As for the slowdown of the global economy, this will weigh on trade and business investment plans as well. Our forecast for GDP growth is 0.6% in 2016 and 0.7% in 2017.
Inflation outlook remains concerning
The appreciation of the yen in trade weighted terms has escalated since the Brexit vote and reached levels higher than before the introduction of quantitative and qualitative easing. In our central scenario we expect the USD/yen to move around 100-105 range. Market participants are already factoring in further stimulus and the yen has now weakened somewhat, but it still has appreciated around 13% (in real effective terms) since the beginning of the year. We think that further stimulus will support inflation and anchor inflation expectations (which have been declining according to bond market measures).
Further monetary and fiscal easing unavoidable
We expect given the post-Brexit impact on the yen and the underlying economic weakness of the Japanese economy, that combined monetary and fiscal stimulus are needed. On the fiscal front, Japanese Prime Minister Shinzo Abe’s sweeping victory in the upper house earlier this month, will give Prime Minister Abe more room to consider a relatively large supplementary budget. Indeed, the Prime Minister mentioned that he would have to accelerate Abenomics to meet the public’s expectations. Although the details are still unclear, the Prime Minister has said that “investment in the future” would include infrastructure investment and provision for nursery education and nursing care. The economic impact of this supplementary budget which would likely be passed in October, will probably only materialise in 2017.
Moreover, in June 2016, the government decided it would postpone until October 2019 a further increase in the consumption tax rate hike. This will mean foregone fiscal revenues for the next two and a half years. At the same time, the government’s interest rate costs are declining as a result of the negative interest rate policy and increasing demand for safe haven assets. This will help the government to partly offset the impact in revenues from the delay of the tax rate hike. On the monetary front, we think the BoJ will likely ease monetary policy further at the upcoming meeting (July 28-29), cutting the policy rate 20bp to -0.3% and raising the amount of its asset purchases to JPY100tn per annum from JPY 80tn. These measures are not expected to have a meaningful effect on inflation this year, but should have an impact in the coming year. Market participants have received positively the prospects of coordinated monetary and fiscal policy.