Political Uncertainty & Monetary Easing Combine

The economy of Japan is the third largest in the world by nominal GDP, and the fourth largest by purchasing power parity according to the IMF. However recent economic data in the form of preliminary readings for Q3 GDP showed that the Japanese economy has moved back into a technical recession printing at -1.6% vs Exp. +2.2% on a Q/Q annualised basis. This has prompted major investment banks to drastically pull back their growth estimates for the country into next year with the possibility of further easing from the Bank of Japan (BOJ). Analysts at HSBC currently expect the Japanese central bank to deliver additional easing as early as Q2 2015, while Nomura have cut their 2015 GDP forecast to 0.8% from 1.7% and expect further monetary easing measures to be implemented by October 2015.

Prior to the release of Q3 GDP the BOJ had already surprised the market with an expansion to its quantitative and qualitative easing programme (QQE), deciding to increase the amount of the monetary base from JPY 60-70trl to JPY 80trl, and triple the purchases of ETF’s and Japanese REIT’s. As a result of this move, the JPY has depreciated aggressively and in combination with the particularly weak growth figures, USD/JPY has risen 12 handles in just over a one-month period, a move which has seen the JPY/USD future fall below the 85.00 level after trading close to 100.00 in the 1H of 2014.

These recent developments have put into question ‘Abenomics’ which are the economic policies of the ruling LDP party and Prime Minister Shinzo Abe. These political policies are based upon ‘three arrows’ of fiscal stimulus, monetary easing, and structural reforms, all of which are now under extreme scrutiny to a point in that the Japanese Prime Minister (PM) has said he would call an early election in order to seek a fresh mandate for its economic policies in addition to postponing an unpopular sales tax rise. To put this in perspective the Japanese economy was already under pressure earlier this year when the initial rise in sales tax to 8% from 5% in April had a much longer lasting effect than was expected by the government and hence with this negative Q3 reading Japan is now in a technical recession. Therefore, PM Abe has said he is to delay the second increase to 10% that was originally scheduled for October 2015 for a further 18 months, and in the interim period the lower house of Parliament has also been dissolved so that a snap election can be held which is expected to be around the middle of December 2014. PM Abe is hoping that by delaying the tax hike he will be able to benefit from increased popularity and has said he would resign if the ruling coalition which now holds two thirds of the seats in the chamber failed to win a majority.

Looking ahead, the future of Japan remains very unclear given the political uncertainty in the coming months and the ramifications that could have on fiscal policy. At this point the JPY has touched a seven year low against the USD and with the Japanese finance minister saying last week about FX rates should be determined by the market the weakening of the local currency may well be a trend that will continue for the foreseeable future. The performance of JPY will largely be hinged upon the result of the snap election which some speculated will be held on 14th of December 2014.