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Fed and ECB as Vital to Japan's Future as Bank of Japan

The Bank of Japan’s recent monetary easing methods had no impact on falling Japanese stocks, making events at the U.S. Federal Reserve and European Central Bank even more important to Japan.

  • David Turner

Institutional investors in Tokyo’s cosmopolitan Otemachi financial district are these days showing as much interest in the pronouncements of central bankers in Frankfurt and New York as in the utterances from the nearby Bank of Japan (BoJ) — and possibly even more.

While investors around the western world wait with bated breath to see if the U.S. Federal Reserve and European Central Bank are prepared to keep bolstering their economies with massive asset purchases or refinancing operations, the BoJ’s revelation that it was buying trillions of yen of extra assets failed on Friday to prevent a further fall in the stock market.

Traders’ underwhelmed response to the BoJ’s move confirms how the course of Japanese markets is being governed more by events elsewhere — particularly in the euro zone — than by the increasingly impotent central bank.

This was underlined by economists’ nervous reaction to Friday’s disappointing numbers for Japan’s export-focused manufacturing sector — an unusually key part of the economy for Japan since underlying long-term growth in domestic demand is low. Government data showed that manufacturers planned to cut production by 4.1 percent in May, and April’s survey of manufacturing purchasing managers by Markit Economics showed a fall in export orders. “Tokyo woke up to a rather chilly rain this morning, and the set of data released this morning was no better,” said Takuji Okubo, Asia chief economist at Société Générale in Tokyo. “Judging by manufacturers’ production plans, they do not seem to have much hope for rising export demand.”

To export successfully, Japanese manufacturers — which dominate the country’s Nikkei 225 stock index — need a weak yen. This makes their prices more competitive abroad as well as improves their earnings by increasing the value of their profits repatriated from overseas.

The yen fell sharply in the weeks after the BoJ’s Valentine’s Day declaration that it would pump more money into the economy by stepping up its asset purchasing in an effort to meet a new inflation goal of 1 percent. Such monetary easing should, in theory, create inflation by reducing the value of the yen, since an increase in the quantity of a currency cuts its value. A weaker currency increases inflation by raising the price of imported goods. The sharp depreciation in the yen sent the Nikkei 225, which is dominated by exporters, to a two-year high of 10,255.

Prompted by continuing underlying deflation, the BoJ has acted again: announcing on Friday that it was increasing the size of its ongoing asset-buying program by ¥5 trillion to ¥70 trillion ($864 billion).  

Shuichi Obata, economist at Nomura, Japan’s biggest securities house, said the move showed the BoJ had adopted an “increasingly accommodative stance.” He predicted “as many as two additional rounds of easing” before the end of the year.

However, many analysts are skeptical that asset purchases will help exporters by reducing the value of the Japanese currency. Capital Economics, the independent macroeconomic consultancy, said in a Friday note, “Additional monetary easing alone is unlikely to prevent a renewed appreciation in the yen in the event of a further escalation of the crisis in the euro zone.” It added, “We continue to expect the yen to climb to 70 against the dollar by end-2012.”

Any attempts to reduce the yen’s value, and hence revive the fortunes of exporters, must struggle against the headwinds of the global economy — and in particular the European currency bloc. This is because the yen remains a classic safe-haven asset, whose value increases during global economic turmoil. A return to another fully fledged crisis in the euro zone would also cut demand for goods imported from Japan by souring sentiment in some of its biggest international markets — delivering a further blow to manufacturing stocks.

The yen was at ¥80.4 to the dollar in U.S. afternoon trading on Friday — an appreciation of 0.7 percent on the day and considerably higher than its ¥84.1 low in late March, before Spain’s fiscal troubles pushed it back up by triggering renewed interest in safe havens. The fewer yen to the dollar, the higher the yen’s value.

Even if some analysts think exporters’ prospects are beginning to grow dimmer because of global turmoil and yen appreciation, some find cause for hope in Japan’s domestic economy — a rare phenomenon in the past two decades of economic paralysis. Building equipment and infrastructure manufacturers have thrived on the construction spending following the 2011 tsunami and earthquake. In a super-Friday of numbers published ahead of next week’s Golden Week holidays, official data show that new job offers grew by 1.6 percent in March — boosted by demand for workers in the labor-intensive construction sector.

Some analysts think this temporary revival in the Japanese economy could create a benign momentum, where a short-term increase in output morphs into a long-term increase. Largely because of reconstruction spending, analysts expect a sharp rise in corporate earnings for the year ending March 2013, which will increase the resources available for reinvesting into the economy.

Yet the virtuous circle of higher earnings followed by higher business investment will eventually break down if Japanese consumers prove unwilling to spend. Friday’s news of a 1.2 percent March fall in retail sales does not suggest that Mrs. Watanabe — the archetypal Japanese shopper synonymous with John Q. Public — is ready to open her purse strings.

The Nikkei fell 0.4 percent to 9,521 on Friday.