Economy

Japan’s rising sun

15 May 2023 • 10 mins read
Japan’s Rising Sun

Governor of the Bank of Japan, Kazuo Ueda, spoke during the presidency press conference at the G7 Finance Ministers and Central Bank Governors' Meeting at Toki Messe in Niigata on 13 May 2023. AFP.

  • Japan’s economy is attracting fresh attention from investors pushing the Nikkei 225 close to 33 year highs above 30,000 this month.
  • Firstly, economic activity is recovering firmly at the start of 2023 after Japan’s slow reopening from the pandemic caused a technical recession in the last two quarters of 2022.
  • Secondly, new Bank of Japan Governor Ueda is continuing former Governor Kuroda’s dovish stance even with four decade-high inflation rates and, third, the JPY is at very weak levels.
  • We expect the BoJ may lift its cap on 10Y bond yields in 2023 as inflation returns. But its deposit rate is set to stay at -0.10% to keep stimulating the economy, thus benefiting risk assets further.

Japan’s economy is attracting fresh attention from investors pushing the Nikkei 225 close to 33-year highs above 30,000 as the chart shows.

Equities and Bonds Japan

Source: Bank of Singapore, Bloomberg.

Firstly, economic activity is recovering firmly after Japan’s slow reopening from the pandemic.

This week’s 1Q23 GDP data shows the economy expanded at an annualised rate of 1.6%, well above expectations, on stronger consumption and capital expenditures. The GDP deflator - a broad measure of inflation - reached 2.0%YoY, hitting the Bank of Japan’s 2% inflation target.

In contrast, the GDP data also showed Japan experienced a technical recession in the second half of last year, contracting at an annualised rate of 1.0% in 3Q22 and 0.1% in 4Q22.

Inflation Japan

Source: Bank of Singapore, Bloomberg.

Secondly, new Bank of Japan Governor Ueda is continuing former Governor Kuroda’s dovish stance even with inflation at four decade-highs.

At Ueda’s first board meeting, the BoJ kept its cap on 10Y bond yields around 0% unchanged. The central bank also maintained its negative deposit rate at -0.10%. Inflation has risen sharply as Japan has reopened as the chart above shows. But officials are concerned inflation will not be sustained at the BoJ’s 2% target without broader wage growth. The central bank forecasts core inflation to fall back below 2% by financial year 2025. Thus, the BoJ is willing to remain dovish to ensure Japan can, over the next couple of years, escape from its last three decades of weak inflation and deflation.

Thirdly, the JPY is at very weak levels. The USD was as high as 152 last year but even at 137 currently, the JPY is still at its lowest levels since 1998 as the BoJ’s dovish stance keeps the currency cheap.

The combination of stronger GDP growth, higher inflation, negative interest rates and the weak JPY is benefiting Japan’s risk assets. We think the BoJ may lift its cap on 10Y bond yields this year as inflation firms - a risk that may cause near-term volatility in financial markets. But the BoJ is set to maintain its deposit rate at -0.10% throughout 2023 to stimulate activity and ensure inflation becomes entrenched around its 2% target. Thus, the BoJ’s dovish stance on interest rates is likely to keep supporting risk assets this year in Japan.

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Author:
Mansoor Mohi-uddin
Chief Economist
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