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MRB's Insight of the Week: Japan has a mountain to climb to defeat deflation
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by Warren Smith on Nov 01, 2013 at 00:01
Global investors have recently lost some of their enthusiasm towards Japanese equities after a burst of excitement related to the government’s new-found desire to escape deflation and stimulate growth.
The yen has stalled at 100 to the US dollar, and Japanese equities have tracked sideways relative to global benchmarks.
However, we remain optimistic that the prime minister and governor of the Bank of Japan will follow through on reforms and policy reflation, allowing the equity market to resume outperforming and for the yen to weaken anew.
The main recent disappointment has been the government’s inability to deliver the so-called ‘third arrow’ – namely economic reforms and restructuring.
Prime minister Shinzo Abe has come up short on details and has lacked the urgency he demonstrated late last year and in early 2013. Perhaps he is waiting for the overall economic backdrop to improve further so that his medicine will be better accepted by those voters who will be disadvantaged by structural reforms, for example, the elderly, farmers and other protected domestic industries.
Coming up short would be economically and politically disastrous. The good news is that the economy has rebounded and prospects are brighter than at any point since the mid-2000s.
A revival in global trade will help sustain the rebound, assuming there is no political backsliding.
Walking the reflationary pathMeanwhile, the Bank of Japan (BoJ)has not backed off from its reflationary path, even though the downtrend in the yen has stalled.
The yen was very oversold and momentum is now unwinding to neutral levels. The delay in Federal Reserve tapering and general political uncertainty in the US have propped up the yen. However, the widening gap between the BoJ and the Fed in terms of balance sheet expansion will favour a weaker yen in the coming year.