As Markets Fret Inflation, Japan's Growth Hurdle Worsened by Yen
A man looks at an electronic board displaying the current value of the yen against the U.S. dollar and the figure of the Nikkei 225 stock average in Tokyo, Japan. (Photographer: Tomohiro Ohsumi/Bloomberg News)

As Markets Fret Inflation, Japan's Growth Hurdle Worsened by Yen

(Bloomberg) -- The slowest economic growth in two years and the strongest yen in 15 months highlight Japan’s ongoing struggle to revive inflation even as prices elsewhere in the developed world begin to inch higher.

Japan’s economy grew at an annualized rate of 0.5 percent in the three months through December, capping an eighth straight quarterly expansion which is the longest stretch in nearly 30 years. But it was a decline from more than 2 percent in each of the previous two quarters, and with the yen’s surge set to lower import prices, the Bank of Japan looks to have an even tougher job hitting its 2 percent inflation target.

A slower expansion and a stronger currency -- if sustained -- will dampen market speculation that policy normalization could be headed Japan’s way.

The yen’s renewed strength won’t immediately affect economic growth or corporate activity, but could take the air out of inflationary pressures, said Junko Nishioka, chief economist at Sumitomo Mitsui Banking Corp. "The fact that this might prolong the BOJ’s easing period is far more serious,” said Nishioka, who is a former BOJ official.

As Markets Fret Inflation, Japan's Growth Hurdle Worsened by Yen

Strong growth in recent quarters, steadily rising inflation and surging global bond yields had fueled speculation that the BOJ would soon follow its global peers in turning toward policy normalization, perhaps by letting its yield target rise. Nearly half of economists surveyed by Bloomberg said they expected the BOJ to take its first step toward normalization this year.

Those expectations have been partly driven by concerns about the sustainability of the BOJ’s stimulus. Rising global yields have challenged the BOJ’s efforts to keep the 10-year Japanese yield at around zero percent. The central bank owns about 40 percent of outstanding Japanese government bonds, and its balance sheet has swollen to nearly the size of the nation’s roughly $5 trillion economy.

Domestic Demand

Still, the GDP report wasn’t a total washout for the reflationist crowd. Economists found encouraging indications in the latest data that domestic demand is gaining traction after exports had done much of the heavy lifting during earlier phases of this expansion.

While exports remained strong in the fourth quarter, it was rising imports that stole the show -- a sign of healthier domestic demand that wiped out the net contribution of exports to GDP. And in other up-arrow signs, private consumption and business investment rose in the quarter.

The "key point" is that the long-elusive "virtuous cycle" of rising business investment and consumption has begun, and is unlikely to be derailed quickly, Jesper Koll, chief executive officer of Wisdomtree Japan Inc., told Bloomberg TV.

But much will come down to the currency. The stronger yen poses a threat to any "virtuous cycle," said Hiroshi Hanada, head of economic research at Sumitomo Mitsui Trust Bank. "All the BOJ can do now is to reiterate its commitment for monetary easing, Hanada said. "They would probably have to take some action if the yen breaks through 100."

What Our Economist Says...
Though the economy looks fairly healthy after two years of uninterrupted expansion, the fourth-quarter slowdown could take some of the wind out of inflation in the near term, Yuki Masujima, wrote for Bloomberg Economics. Masujima also cited a strengthening yen and rising U.S. protectionism among the risks to the outlook.

©2018 Bloomberg L.P.

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