InvestmentsJan 19 2015

Will easing end Japan’s woes?

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Of all the economies battling monetary and fiscal issues, Japan has been at the coalface for the longest.

But in recent months the country has surprised investors with its determination and resulting monetary policy measures.

The Bank of Japan (BoJ) caught markets by surprise in October 2014 with the announcement of additional quantitative and qualitative easing (QQE). This move coincided with a change of asset allocation by the ¥130.9trn (£728bn) Government Pension Investment Fund of Japan, which included a reduction in domestic bonds and increased equity exposure.

Combined with prime minister Shinzo Abe’s successful ‘snap’ election in December and mandate for further reform, this could mean there is a potential end for the country’s economic woes, or does it?

Govinda Finn, investment research writer at Standard Life Investments, says: “The BoJ has been battling deflationary forces for longer than most and, as the inventor of quantitative easing, it has a decent track record of policy innovation. However, for all its clever thinking it has consistently lacked conviction.”

He points out the latest QQE is “designed to rehabilitate the credibility of the BoJ’s price stability mandate”, particularly the inflation target of 2 per cent. At the same time the bank has expanded its balance sheet and it expects its assets to GDP to reach 75 per cent this year.

One of the triggers for the increased monetary easing has been the fact consumer prices have been slow to move towards the elusive 2 per cent target, with the latest consumer prices index (CPI) figures for November showing a year-on-year rise of just 0.9 per cent.

“Many think a continuation of the previous trend or a moderate increase in prices is considerably more conceivable than a 2 per cent price growth,” Mr Finn warns. “To overcome this, it is argued the BoJ’s policy needs to exceed all rational expectations.”

Ian Winship, manager of the BlackRock Absolute Return Bond fund, thinks the complementary policies of the government and central bank should prove positive for the country if the easing continues.

“There is a belief that if it doesn’t work, [BoJ governor Haruhiko Kuroda] will do more. There has been reform; [Japan has] gone through the first stage of the rise in sales tax and that has allowed the bank to do more. It gives us tremendous hope that if it can continue with this level of co-operation, there is a way out for the Japanese economy.”

But Mr Finn points out: “October’s expansion of QQE was designed to demonstrate that people still underestimate the BoJ’s commitment to its price target. However, further easing may yet be required and surprising expectations again is likely to prove increasingly difficult, while liquidity issues in the Japanese government bond market highlight the practical limitations of further QQE.

“Future price expectations are also likely to be dampened by the slowdown in current prices, with core CPI set to fall still further as the recent oil weakness feeds its way through the economy.”

Mr Winship remains slightly more optimistic and suggests that while the focus is on Japan and Europe, their central banks are “doing all right and not making mistakes”. He says: “I think maybe Japan and Europe will, over time, move closer to the UK and US, rather than the reverse.”

That said Mr Finn notes the limitations of monetary policy means a co-ordinated approach from government is essential.

“A combination of monetary, structural and fiscal measures will allow policymakers to better tackle the causes of deflation,” he says. “Setbacks such as the recent postponement of the scheduled consumption tax hike in 2015 may raise questions in the short term about how the government will achieve its target of a primary surplus by 2020.”

Nyree Stewart is features editor at Investment Adviser

ECONOMIST VIEW

John Greenwood, chief economist at Invesco Perpetual, says:

“A striking feature of the next year or two will be the marked divergence in the monetary stance of central banks in the US and the UK on the one hand, and Japan and the eurozone on the other.

“Whereas the Federal Reserve and the Bank of England are both likely to be raising interest rates from the second half of this year, the European Central Bank and the Bank of Japan are expected to continue with asset purchases and zero interest rates.

“However, we should be careful to distinguish between rising rates because economies are returning to normal and tighter monetary policy. If commercial banks expand bank credit more rapidly, then rising rates may not mean tight money.”