SBM JAPAN UPDATE

The Bank of Japan has announced new measures in a desperate and bold attempt to fight the deflation the country has been facing over the last two decades. Following pressure from the recently elected Premier – Shinzo Abe, the BOJ introduced a new target for the inflation rate in conjunction with the announcement of an open-ended asset purchase program. The measures mark a clear change in policy but still may not be enough, and also putting the independence of the central bank at stake. Investors took the opportunity to book profits on the announcement on the Nikkei and the yen has regained some strength against major currencies.

As reiterated several times by Shinzo Abe, one of his main priorities is to bring growth back to Japan and try everything possible to push inflation higher as nearly 2 decades of deflation has wreaked havoc on the economy.

Abe made a credible threat with regards to monetary policy at the outset of his premiership and since then the yen dropped almost 13% against the US dollar as investors positioned themselves for the BOJ moving in the direction of the US Federal Reserve and really putting the foot on the monetary easing pedal. Last night, the BOJ announced a new target for inflation to be held at 2% and an open-ended asset purchase program amounting to 13 trillion yen ($145bn) a month.

At first glance, the moves seem to be in the right direction but, doubts persist in some quarters. As discussed by the governing council, some members see a 2% target inflation rate as unrealistic. It may take much more than bold monetary action to put the necessary pressure on prices after such an entrenched deflationary consumer psychology. Some commentators see more coordinated action being needed. Over the last three years, average prices in Japan have retreated and the last time the inflation rate was seen above 2% was in 1991, more than 20 years ago.

The BOJ will however delay the open-ended program until 2014 – the primary trigger for profit taking and explanation of disappointment to investors, some of whom expected more immediate action. There’s no doubt a change in policy is already in place and that Abe will use his power to go even further, in particular by replacing the current BOJ governor with a new (probably more politically influenced) one in April, but for now, the 13% drop in yen against the US dollar and almost 20% against the Euro in two months may have run its course whilst investors wait for new clues.

The uptrend observed in the yen has been accompanied by a 25% rise in Nikkei – far outperforming other global markets in recent weeks and that we flagged almost at ground floor level here at SBM in early November. After years of underperformance relative to its peers, the Japanese equity market has finally taken off.

With a new strong commitment from the BOJ and the Japanese Premier to make the economy prosper again, we still expect the Nikkei to continue this trend as valuations remaining compelling, especially given the inherent operational leverage of this market but expect a retracement back to 10,000 in the forthcoming weeks. With regards to the yen, there’s no doubt the Japanese currency will be pressured down in medium term u as with the Nikkei, the yen may retreat a little futher back towards the 85 level in the near term For those that have bee reading our blog and were able to sell the yen a few months ago, this may be a good point to close positions. The forthcoming debt ceiling discussions in the US may favour Yen strength as we saw in August 2011.