Yves Nosbusch

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Japan: the surprises keep coming dotted

Surprise intervention by the Bank of Japan on 31 October, unexpected contraction in output during the third quarter, surprise announcement on Tuesday by Prime Minister Shinzo Abe to call early elections and to postpone a hike in the VAT rate which was scheduled for 2015: the news coming out of Japan over the last few weeks have caught most observers by surprise. How should these announcements and the sometimes violent market reactions be interpreted? What are the likely medium-term consequences for the Japanese economy?


The recovery stalls

After a promising start to the year, the beneficial effects of Abenomics – the Japanese government's ambitious stimulus programme – have run out of steam in recent months. Output contracted sharply in the second quarter and, according to the first estimates, the third quarter has also seen negative growth of -0.4% relative to the previous quarter.


It is important to remember that the sharp rise in consumption at the beginning of the year was primarily due to the approaching VAT hike from 5% to 8% in April. Since the higher rate has taken effect, this trend has reverted to the point of largely cancelling out any previous beneficial effects. Growth has also suffered from the fact that exports have failed to take over from consumption since April despite the sharp depreciation of the yen. In fact Japanese exports have stagnated. A key reason for the lacklustre export performance is that with an unemployment rate of 3.6%, Japan is currently near full employment, which means that Japanese businesses are finding it difficult to hire workers to increase their production capacity in the short term.


Growth is thus expected to be fairly disappointing in 2014. In the face of these headwinds, the Japanese Prime Minister called early elections on 18 November and he announced the postponement until 2017 of a second hike in the VAT rate (from 8% to 10%) which was scheduled for October 2015.


Large-scale bond purchases

The Bank of Japan had already surprised most observers on 31 October when it announced a significant expansion of its bond purchase programme. For the central bank, the main objective is to prevent a slip back into the deflationary environment which has proved so harmful to the country in recent years. It has therefore decided to considerably increase its purchases of Japanese government bonds. Going forward, these will be of the order of over 15% of GDP – a far larger programme than those implemented in recent years by the US and UK central banks.


The almost instantaneous effect of this large-scale monetary easing has been increased inflationary expectations and yen depreciation. As shown in the graph, the markets were not expecting these measures at this stage, which explains the violent adjustment in the exchange rate on the day of the announcement. The highly positive reaction of Japan's equity market can be attributed first to the fact that equities are less sensitive to inflation than other investments, particularly bonds. Moreover, the decision (taken at the same time) to invest a significantly larger share of the public pension fund portfolio in equities in the future has also contributed to this sharp rise in equity prices.



Equity market and exchange rate reactions

Sources: Macrobond, BGL BNP Paribas




What are the risks?

Japan is facing a considerable demographic challenge, one that is set to worsen in the coming years. The country's ageing population and limited immigration will lead to a sharp decline in the working population and, to a greater extent, of its share in the total population. With the Japanese economy already close to full employment, the problem would not seem to be the result of depressed demand that could be stimulated by monetary and fiscal easing. On the contrary, the real risk is that this policy could lead to inflation while failing to stimulate growth on a lasting basis.


Yves Nosbusch

Chief Economist

BGL BNP Paribas


Published in the Luxemburger Wort (in French) on 20 November 2014