Strength of the yen weighs heavily on Japan’s economy

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Japanese trade data has been heavily impacted by the recent appreciation of the yen (up 15% versus the US dollar so far this year – see exhibit 1). The strength of the yen has led exporters to cut prices in Japanese yen terms, while prices of imports have also fallen. As a result the value of both exports and imports has plunged.

Exhibit 1: The strong appreciation of the Japanese yen in 2016 and the fall of the Nikkei are totally at odds with what Messers Abe and Kuroda are trying to deliver. If these trends continue it is likely the government will be pushed into action using both its fiscal and monetary arms (the graph shows changes in the Japanese yen versus the US dollar (right-hand side) and the Nikkei (left-hand side) between January 2014 and 22 June 2016).

japanese yen and nikkei

Source: Datastream, BNPP IP, as at 27 June 2016.

Exhibit 2: Brexit has triggered further appreciation of the yen and thereby rachets up the pressure on the Bank of Japan for monetary policy action

JYS Curncy (JAPANESE YEN SPOT) 2016-06-28 14-08-05

Source: Bloomberg, as at 28 June 2016.

The value of Japan’s merchandise exports declined 11.3% year-on-year in May and imports were down by 13.8%. Japan’s exports have now fallen for eight months in a row. However, for the impact on GDP growth we should look at volumes. In volume terms, the trend in Japanese foreign trade looks much less dramatic. Imports rebounded from a dip in April, but the broad trend is flat for both exports and imports. For corporate earnings, values are more relevant. Given the strength of the Japanese yen since the start of the year, it should be no surprise that forward earnings estimates for Japanese companies have fallen sharply.

Exhibit 3: The value of Japan’s exports fell by 11.3% in the twelve months to May 2016. It is the eight consecutive month in which the value of Japan’s exports has fallen. The fall was led by a steep contraction in the value of exports to China, Japan’s largest trading partner. Japan exports

Source: Datastream, BNPP IP, as at 27 June 2016.

Another weakness has been recent consumer spending. There are many measures and some tend to be volatile, but supermarket sales fell by 1.3% YoY in May and department store sales were down by 5.1%. This was the sharpest annual decline since mid-2010, except for temporary dips due to a tax hike and natural disasters. If anything, it is up to consumption to drive the Japanese economy forward. Foreign trade poses a challenge with the Chinese economy slowing and the yen having strengthened. Employment growth should provide purchasing power and low unemployment should at some point support wages. But the spring wage negotiations have disappointed and actual wage growth has been minimal. This may matter for the Bank of Japan.

A stronger currency and a weak economy should induce the central bank to boost stimulus. The minutes of the late April monetary policy meeting did not reveal any urgency for more stimulus as the general sense was that most of the headwinds for the Japanese economy came from abroad. However, policymakers acknowledged that inflation was lower than expected and that inflation expectations had weakened.

Brexit has triggered flows of capital into the yen, arguably the ultimate safe-haven currency. On Friday 25 June, the yen briefly breached USDJPY 100 (see exhibit 2 above). This rachets up pressure on the BoJ and increases the probability of further monetary easing.

The next policy meeting on 28-29 July will be accompanied by new growth and inflation forecasts by the Bank of Japan. It will occur after the Upper House elections and most likely follow an announcement of additional fiscal stimulus. So, there are some moving parts here, but since the forecasts are likely to include lowered inflation estimates, the BoJ may finally feel encouraged to step up the easing measures. In the wake of Brexit the possibility of the BoJ convening an emergency meeting to ease policy sooner than the scheduled policy meeting cannot be ruled out. [divider] [/divider]

This article was first written on 27 June 2016, in Amsterdam.

Read also the introduction of negative policy rates by the Bank of Japan.

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