Japan strikes it lucky in the battle against deflation

Japan strikes it lucky in the battle against deflation

Prime Minister Shinzo Abe was the first foreign leader to meet Donald Trump after the US election, and things in Japan have been looking up for Mr Abe's government. (File photo)
Prime Minister Shinzo Abe was the first foreign leader to meet Donald Trump after the US election, and things in Japan have been looking up for Mr Abe's government. (File photo)

Japan, long a hard-luck case when it came to the impact of fiscal and monetary policy, these days is catching break after break.

Prime Minister Shinzo Abe and the Bank of Japan's long-running quest to rekindle inflation to a sustainable 2% rate and with it fan growth have suffered a variety of insults and injuries, many of the latter self-inflicted.

Abenomics, the combination of fiscal stimulus, extraordinary monetary policy and hoped-for structural reform, has not performed as advertised. Wages rises have remained stubbornly low and the decision in early 2016 to take interest rates into negative territory only served to undermine financial intermediation.

Things lately, however, have been looking up. Firstly, or should I say "bigly", is the Trump effect on the dollar. Whatever the ultimate result for America, Donald Trump's advent has made the dollar great again, as markets bet he'll deliver fiscal stimulus, stoking inflation and interest rates. That's driven a more than 9% rise in the value of the dollar against the yen since just before the election, a move which helps to import inflation and improve the competitiveness of Japanese exports.

The yen's move downward has been accentuated by the Bank of Japan's decision in September to pin 10-year interest rates at zero, just above its short-term rate of -0.1% in a policy it calls yield curve control.

"Hats off to the BoJ for its sense of timing. Pegging 10-year Japanese government bonds at 0% in September, while global bond yields were still close to their lows, has proved a brilliant idea," Societe Generale strategist Vincent Chaigneau wrote in a note to clients.

"The surge in global bond yields is now causing a sharp widening in rates differentials, pushing the yen much lower."

The second break, though only in the sense of an inflationary push, is the rise in the price of oil, aided most recently by the Organisation of the Petroleum Exporting Countries' production cut agreement last week. This has sent Brent crude 19% higher since Wednesday, to above $55 (1,960 baht) per barrel, the highest in 15 months.

"The BoJ's task in reaching its inflation target may well begin to appear less hopeless than it has in recent times. While there may be widespread recognition that any such rise in reported inflation is to be attributed to once-off factors, there is likely to be an improvement in sentiment that could help to lift growth in the economy," Stephen Lewis, chief economist at ADM Investor Services, wrote to clients.

Japan's core consumer inflation, including oil products but excluding fresh food, fell 0.4% in October.

"Less hopeless" is high praise so far as BoJ actions go, though their fight to try to effect rising prices as the population declines is likely unwinnable.

It is hard to decide which accusation to hurl at the Bank of Japan's policy of controlling the yield curve. Is it a cargo cult or is it homeopathy?

Cargo cults confuse those things which accompany the desired outcome with the thing itself. Thus having a jungle air strip is believed to make planes and cargo appear. So it is with positive yield curves, which go along very often with growth and inflation, but which by no means assure or cause them. At best it may have established a firebreak against damage to institutions like banks and insurers which depend on positive yield curves to survive.

And like homeopathy, in which supposedly medicinal substances are diluted to infinitesimal levels, a 10-basis-point slope between short and 10-year rates is too tiny to inspire much of a reaction.

The more immediate question is whether the effect of Trump policies remains benign for Japan. Markets' first move has been to price in the impact of Trump's promised stimulus while largely overlooking his previous fighting words on trade.

Mr Trump's Twitter-delivered attack on Chinese currency management and trade policy over the weekend, combined with his phone call with Taiwan's president is enough to raise reasonable expectations of a tariff battle. That would be terrible news not just for world economic growth, but generally for Asia and more specifically for Japan.

Even if somehow Japan can avoid trade strains with the US directly, it is part of a complex web of intra-Asian trade which is highly exposed to the US-China economic bargain. China is Japan's largest trade partner, and a substantial percentage of that is goods ultimately bound for the US. That would overwhelm the impact of a weaker yen, leaving the BoJ grappling once again with the unhappy demographic fundamentals.

Japan can enjoy its unexpected lucky break only so long as Mr Trump delivers on his stimulus promises but not his trade threats. REUTERS

James Saft is a Reuters columnist.

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