Japan Edges Towards the Cliff

The Japanese economy continues to weaken and a recession is now the main consensus. The country’s trade balance, which was long in surplus, is now moving deeper and deeper into deficit and the third quarter numbers almost certainly will show contraction, and these are more than likely to be followed by another set of negative readings for Q4

The political climate is increasing turning towards a unanimous dose of BOJ intervention and our view is that the pressure on the central bank will only grow. While the BOJ will undoubtedly try to resist this not least because it the current governor’s informed decision that QE has little impact on growth and inflation, the political establishment thinks otherwise.

The consumption tax hike which is set to be phased in from 2013 to 2015 is predicated on a return to inflation of 1% and the BOJ is likely to be used as a vehicle to get there.

The BoJ delivered further easing at its recent meeting, as expected.  The easing included: an increase in the Asset Purchase Program target; a new bank lending facility, similar to the BoE’s Funding for Lending scheme; and a statement making clear the government and the BoJ are ‘on the same page’ when it comes to eradicating deflation.

While we are sympathetic to the view that QE solves little in the long run, Japan is running out of time given its massive government debt a government debt level which is deeply rooted in the economy’s structural incapacity to produce domestic driven demand. Japan’s problem is largely demographic, and at this stage of the game this has no evident structural solution beyond increasingly reckless expansion of the BOJ’s balance sheet. A turnaround in the birth rate is unlikely, and even were one to happen, it would be at least a quarter of a century before any impact was noted.  Furthermore, a significant change of attitudes to immigration is unlikely.

Our base case then remains for further political encroachment on the BOJ’s domain and further balance sheet expansion by the central bank.