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Is Japan heading to troubled waters?


During its policy meeting last Wednesday, the Bank of Japan signalled its intention to maintain Quantitative Easing measures, such as maintaining ultra-low interest rate policy, purchasing ETFs and J-REITS, and continuing corporate lending programs as well as corporate bond purchases until at least March 2021.

In addition, the bank also decided to continue its debatable negative interest rate policy by applying an interest rate of negative ten basis points to any current accounts held at the bank and set its 10-year Japanese Government Bond rate target at near zero.

With the serious threat of the pandemic still ongoing and deflation already present, the bank’s actions were not all that surprising. From both the consumer and producer side, prices have fallen rapidly; the bank itself is projecting the Consumer Price Index to fall to at least negative 50 basis points through March 2021.

In addition, the latest data from the June statistical survey that reflects current business outlooks in Japan (TANKAN survey), should have set off alarms among the members of the policy board as a majority of firms reported unfavourable business conditions and excess supply/capacity. Hence, deflationary conditions are almost certain to persist in the near future.

As expected, as business conditions are more unfavourable, the output gap which occurs when potential GDP is greater than real GDP, grows more negative. As one of the main determining factors of inflation, the existence of an output gap implies movement in inflation, and in this case towards deflation.

From the producer side, economic data such as the supply-demand diffusion index and price index from the TANKAN survey also suggests more deflation in the future. Logically, as more firms report excess supply as opposed to excess demand, more firms tend to report falling prices, and vice-versa. This relationship is not entirely strong as there are significant outliers, however, a positive linear trend does exist.

Besides deflation, Japan also faces a dreary outlook for growth. In April, the Bank of Japan reported it was projecting the economy to shrink between 3 and 5 percent this year; in its latest meeting, the bank updated its projection to a more precise figure of -4.7 percent.

This issue of persistent deflation and deteriorating growth prospects is reminiscent of the 2008 financial crisis – a fundamental structural issue the entire developed world faced. Ironically, despite these dimming growth prospects and deflation expectations, Japanese firms are still reporting a net labour shortage even though that seems to be on track to change.

The question that remains is whether the monetary policies that the Bank of Japan has put in place will be enough to mitigate any prospective hysteresis effects that could set in as a result of this pandemic/economic crisis. Furthermore, reflecting similar environments in the U.S. and Europe, Japan’s monetary policymakers seem to have washed their hands of any further action post initial stimulus, and become stuck in trivial political disputes. With this uncertainty present, Japan seems to be in a troubling situation.

This article was issued by Maria Fenech, Credit Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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