Will Abe continue to pull rabbits out of his hat?

Firstly, he sidestepped concerns on fiscal solvency to ensure the passage of a ¥13trn (£87.5bn) supplementary budget in February. Then, he presided over a transformation at the Bank of Japan (BoJ) in April, with incoming BoJ governor Haruhiko Kuroda announcing a new 2 per cent inflation target amid a shift in monetary policy. Finally, in June, Mr Abe presented a wide-ranging package of reforms as part of a ‘growth strategy’.

Yet, while his daring stunts have already wowed a rapt audience, there are few signs that he is about to disappear in a puff of smoke. Indeed, having recently secured the type of broad political support that has eluded the majority of Japan’s 32 post-war prime ministers, he may finally be able to push through much needed reforms. But what will be Mr Abe’s next move and will investors be amused?

The most potent mix of policy response is likely to continue to focus on driving Japan out of its current deflationary quagmire. BoJ governor Mr Kuroda recently reiterated his belief that the current policy framework, including the increase in the monetary base (at an annual pace of ¥60-70trn), will be sufficient to achieve the Bank’s 2 per cent inflation target. Certainly, the economy does appear to be on track with expectations at the BoJ – in April, the Bank predicted that the economy will return to a moderate recovery path around mid-2013.

Yet, in spite of recent improvement, it is worth pointing out that achieving the inflation target outlined by the BoJ is central to all other aspects of Abenomics. If there was to be any slippage on this front, the credibility of the second and third of Mr Abe’s arrows – fiscal flexibility and a growth strategy – would also come into question. Consequently, investors are probably right to assume that more action is possible if inflation disappoints.

Let us next consider how Mr Abe’s fiscal strategy may develop in the coming months. Much has been made of the huge debt obligations of the Japanese government, with debt-to-GDP now close to 220 per cent. In addition, the economy is hindered by poor demographics and a considerable public welfare burden.

Clearly, reconciling the current debt situation with the underlying growth trajectory is going to require painful decisions. However, hopes for greater prudence in government spending must be balanced against Mr Abe’s desire to drive the economy towards nominal growth of 3 per cent. Mr Abe is rumoured to be considering a further supplementary budget to offset the negative impact of a planned hike in the consumption tax to 8 per cent in April 2014. The size of this budget may prove a crucial indication of how achievable the government’s target to halve the primary deficit by 2015 will prove.

The final front of Mr Abe’s assault on Japan’s economic malaise is the ‘growth strategy’, which was unveiled on June 14. There has been a sense that Mr Abe has been rather unforthcoming about the scale of structural adjustment required in the economy, and the impact that this will have on Japan’s population. However, with the Upper House election out of the way, can we expect a more honest appraisal, and more meaningful change?

One factor that has been placed front of Mr Abe’s growth strategy is the Trans-Pacific Partnership trade agreement, with Japan joining trade talks with its regional partners in July. The Japanese government estimates that scrapping all customs duties with TPP members could provide a net economic boost of ¥3.2trn (about 0.7 per cent of GDP).

The impact on the economy could even be higher if the benefits of deregulation and a harmonisation of trade rules are considered. Yet, there is an obvious dilemma here for a prime minister who has been swept to power thanks to a powerful rural support base. It already appears that the Japanese government is seeking waivers for a number of key agricultural products, including rice, hardly the most encouraging omen. Consequently, these trade negotiations are likely to prove difficult and could easily overrun the December target to reach agreement.

There is also a sense of concern over other aspects of Mr Abe’s growth strategy with labour market reform and reform of the electricity market already attracting criticism from vested interests. In addition, attempts to restart nuclear power plants are likely to be fraught with difficulties, with widespread opposition to Mr Abe’s proposal for nuclear power.

Of course, the prime minister does not need to make every policy proposal a showstopper. However, after such a surge in Japanese shares – more than 40 per cent year to date – investors will be increasingly keen to see evidence in coming months that there is indeed substance to match his undoubted style.

Andrew Milligan is head of global strategy at Standard Life Investments