The Bank of Japan decided to raise interest rates from 0.1 to 0.25 per cent, which, although anticipated by some analysts, caused a stir in the markets. The immediate effect of the decision was a strengthening of the yen and a 1.4 per cent drop in the USD/JPY pair. This is a good time to take a closer look at Japan's current economic situation and to consider how this fundamental change might affect companies there.
Table of contents:
- A failed economic experiment time to end
- The strengthening of the yen and the impact on markets?
- What is the future for Japanese business?
A failed economic experiment time to end
Japan's economy is said to be a testing ground for the rest of the world. However, even Japan being an island does not exist in economic limbo. The quantitative easing programme, conducted almost continuously since 2001 by buying Japan's debt from the market, has not fuelled economic growth. Today, Japan's GDP is at the same levels as in 1993!
Source: Tradingeconomics
Despite having the highest debt level in the world, at 266 per cent of GDP in 2023, Japan has managed to avoid a financial crisis thanks to a unique economic strategy. The Bank of Japan (BoJ) has bought up around 54 per cent of the country's total public debt, a significant proportion of its liabilities. Research by the US Fed highlights that Japan has managed its debt effectively for more than two decades thanks to a specific ownership structure, including pension funds and the government's strategy of investing in global equity markets. Large asset holdings, such as pension funds, allow Japan to maintain high debt levels with minimal debt servicing costs. In the United States, the situation is different - the smaller gap between the return on assets and the cost of borrowing and the different structure of savings and investments make the Japanese strategy inapplicable there.
The strengthening of the yen and the impact on markets?
Over the past two weeks, the Japanese yen has strengthened by 7.6 per cent against the US dollar. However, it is worth remembering that the JPY had previously lost 45 per cent to the USD over a three-year period. The current rise in the Japanese currency is largely due to increasing pressure on the Bank of Japan to raise interest rates in response to inflation, which stands at 2.8 per cent and slightly above the Bank's inflation target.
Source: Conotoxia MT5, USDJPY, Daily
The weakening of the yen has particularly benefited Japanese companies, which rely heavily on exports but have not shown significant growth in recent years. The weaker local currency naturally boosted export profits, which has been one of the main factors behind the 44 per cent rise in Japan's main Nikkei 225 index over the past three years, breaking through its historical peaks. The profits of the companies comprising this index have risen by a total of 32 per cent over this period. Therefore, the current rapid strengthening of the yen has contributed to the recent sell-off in equities from this market, which have fallen by 9.5 per cent from their peaks.
Source: Conotoxia MT5, JP225, Daily
What is the future for Japanese business?
If the strengthening of the Japanese currency continues, we could witness a reversal of the upward trend in the Japanese market. Currently, companies there, rather than competing with innovation in international markets, are benefiting most from the devaluation of the yen. However, it appears that the current strengthening of the currency is temporary as, despite the increase in interest rates, they are still well below inflation, which does not materially change the economic fundamentals behind the weakness of the Japanese currency.
Grzegorz Dróżdż, CAI MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
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