BOJ Promises Cake Tomorrow

One of the major challenges facing the world’s third largest economy, Japan, is deflation. Deflation has bedevilled Japan for most of the past 20 years; and so for most of this time, the Liberal Democratic Party which forms the newly elected government, has presided over it. It sees consumers and businesses deferring major purchases as long as possible because deflationary pressure means that goods are likely to cost less when the purchase is eventually made. Prime Minister Shinzo Abe, has made it clear that he wishes to see the Bank of Japan adopt aggressive measures to tackle deflation and boost the economy. It seems they have been listening.

The Bank of Japan has announced that it is doubling its target figure for inflation to 2% and will embark on an open ended policy of buying assets. However, the asset purchase programme which is similar to the Federal Reserve’s quantitative easing measures will only be introduced in January of next year. The move will (eventually) pump billions of Yen into the economy and should boost liquidity.

The Prime Minister has pledged that his government will increase spending on infrastructure as a mechanism to spur growth. Japan already has the largest public debt burden of any industrialised country, so questions must be asked as to how this will be funded. Any loss of confidence in Japan’s ability to meet its obligations would be likely to force up borrowing costs in the way seen during the worst of the European sovereign debt crisis.

Analysts suggest that the moves announced by the BOJ and the government will further weaken the Yen. In turn, this will make Japanese goods more affordable in importing markets, but means that the cost of energy production and other raw materials will rise. Japan has been forced to increase imports of fossil fuels to compensate for the loss of nuclear generation capacity with nuclear power plants taken off-line as a result of the March 2011 earthquake and tsunami. The generation capacity was taken off-line as a precaution and for safety tests, but public opinion has turned against the industry and this is why capacity has yet to be restored.