Thursday, November 15, 2012

Prepare For 'Seismic Shift' in Japan?

Barrie McKenna of the Globe and Mail reports, Election call puts spotlight on Bank of Japan:
A surprise Japanese election is expected to ratchet up pressure on the Bank of Japan to do more to kick-start an economy hobbled by monster debts, deflation and shrinking GDP.

Prime Minister Yoshihiko Noda said Wednesday he’ll dissolve the lower house of parliament Friday and call a snap election Dec. 16 as he battles tumbling poll numbers and the spectre of another recession.

It’s an election pollsters say Mr. Noda will almost certainly lose.

That paves the way for a return to power of Shinzo Abe, leader of the once-dominant Liberal Democratic Party, who is expected to pressure the Bank of Japan into much more aggressive monetary easing as a way out of the country’s economic funk.

“We’ll let the people decide which of us is more qualified to lead the country out of deflation and get the economy back on track,” Mr. Abe told Mr. Noda during a heated exchange in the house.

The imminent election sent the yen to its largest one-day plunge versus the U.S. dollar in eight months as investors braced for even further stimulus. The yen also fell against most other major currencies, including the Canadian dollar.

The prospect of the LDP’s return after a three-year hiatus means Mr. Abe would “further exert his influence on the Bank of Japan to step up its activism ... by way of more extensive assets purchases,” argued Ashraf Laidi, chief global strategist at City Index/FX Solutions.

Mr. Abe is also a foreign-affairs hawk, recently promising to take a more muscular stand against China in territorial disputes and to rescind previous government apologies for Japan’s World War Two atrocities.

The political turmoil comes just days after the release of data showing that Japan’s economy is shrinking again – 0.9 per cent (3.5 per cent annualized) in the third quarter, which ended in September.

Major exporters, including Sony Corp. and Panasonic Corp., are busily slashing spending plans as they grapple with mounting losses and stiff competition from China, South Korea and elsewhere.

Many economists say Japan may already be in recession – often defined as two consecutive quarters of GDP contraction. Another recession would be the country’s fifth in 15 years.

Japan eked out GDP growth of just 0.1 per cent in the second quarter. The economy also shrank in the fourth quarter of last year.

The weakening economy has been a source of mounting tension between the government and the central bank in recent months. Government officials have repeatedly called for more monetary easing to go along with interest rates that are already near zero.

Bank of Japan Governor Masaaki Shirakawa, on the other hand, wants the government to do more to rein in government debt, which has now hit 230 per cent of GDP – the worst in the Group of Seven.

In October, Mr. Shirakawa acknowledged that the central bank has struggled to fight deflation and spur the economy. Over the years, it has used most of the monetary policy tools used by other banks, including buying government bonds and expanding the money supply. “I feel there’s almost none that the BOJ hasn’t tried,” he told reporters.

Mr. Abe and the LDP could soon be in a position to overhaul the BOJ, and perhaps shift monetary policy. Mr. Shirakawa’s term is set to end in April. Two of his key deputies’ tenures end in March.

Mr. Noda’s Democratic Party of Japan (DPJ) has a comfortable majority in the lower house but depends on other parties to push legislation through the upper house.

The DPJ ousted the LDP from power in 2009 after more than 50 years of almost uninterrupted rule with promises to cut spending and hold the line on taxes. But faced with a soaring deficit, the government instead nearly doubled the 5 per cent sales tax, leading to a revolt in Parliament and sending Mr. Noda’s poll numbers plunging.
In her article, Catherine Boyle of CNBC reports, Prepare For 'Seismic Shift' in Japan:
While the world's eyes have been turned towards the changing of the guard in neighbor China, Japan is braced for huge change in its political and monetary leadership in the next few months.

The slow-growing Asian economy was at the front of market concerns for the first time in months Thursday, with a notably weaker yen (JPY) and the Nikkei jumping nearly 2 percentage points. A weaker yen in the medium term could help boost sales at big Japanese exporters like electronics giant Sony, and consequently help stimulate growth.

Japan could move to sub-zero interest rates if, as looks likely according to recent opinion polls, opposition party LDP, led by Shinzo Abe, is elected.

Abe said Thursday that he wants the Bank of Japan (BoJ) to bring interest rates down to zero, or even below zero, to stimulate lending.

He has previously called for the BoJ to embark on "unlimited" monetary easing to return to inflation after years of deflation. The current target for inflation is just 1 percent, but Abe wants to raise it to 3 percent.

"With Shinzo Abe a very vocal proponent of more aggressive BOJ policy easing in order to tackle deflation, the financial markets can now begin to price more confidently the risk of more overt political pressure on the BoJ to rid Japan of deflation," Derek Halpenny, European head of global markets research, Bank of Tokyo-Mitsubishi UFJ, wrote in a research note.

"Pressure on the BoJ after a probable LDP election victory is likely to build."

Abe may get to enact his plans sooner rather than later. An election in December appears to be on the cards, after Prime Minister Yoshihiko Noda said he would dissolve the Diet - Japan's parliament - as early as Friday, as long as the opposition agrees to electoral reform.

Whoever is elected will have to pick a new Governor of the Bank of Japan in April, when incumbent Masaaki Shirakawa's term finishes. Since starting in 2008, Shirakawa has continued the policy of monetary easing, but failed to solve Japan's long-term issues with deflation.

"There is a seismic shift in terms of the potential backstops for the Japanese economy," Jeremy Stretch, head of currency strategy at CIBC, told CNBC Thursday.

"The Nikkei has had its fire lit by the move towards an election. Clearly that has pushed up dollar-yen significantly."

There are also worries that the Japanese government will downgrade its forecasts for economic growth for the fourth month in a row on Friday.

The Bank of Japan will meet for its regular rate-setting meeting on Tuesday.

"The BoJ have been struggling to get ahead of market expectations. If we were to see that unlimited intervention, that would help to keep the yen somewhat weaker than is sometimes the case. It continues to be well out of line with the underlying fundamentals," Stretch said.

Halpenny argued that real yen weakness will probably happen next year.
Japan has struggled with deflation for years. Asking the Bank of Japan to engage in "unlimited monetary easing" to stoke inflation would have a profound impact on global markets, one that asset allocation committees around the world will be paying close attention to.

But there is another seismic shift going on in Japan, one that is receiving little press coverage. Suzanne Bishopric, Director of the United Nations Investment Management Division, sent me an interesting article from the Japan Times, Pension cut set to match with deflation:
A Lower House committee approved a plan Wednesday to reduce pension payments that the government has kept unchanged despite declines in consumer prices.

Lawmakers from the Democratic Party of Japan, Liberal Democratic Party and New Komeito voted to implement a 2.5 percent reduction in three phases from October 2013 to April 2015.

While the panel also approved a plan to provide a monthly payment of ¥5,000 to low-income pensioners, benefit reductions may draw criticism from current recipients who will have to bear reductions as well as workers who are currently paying into the plan but will eventually be hit by benefit cuts.

A revision to the National Pension Law and a bill to provide benefits to support pensioners are expected to be enacted during the current Diet session through Nov. 30, after approval by a plenary session of the Lower House on Thursday and later by the Upper House.

Under the revision, a 1 percent reduction will be made in the first phase starting next October. An additional 1 percent cut will be implemented in April 2014, followed by a 0.5 percent reduction in April 2015.

This means that next October, the monthly basic "kokumin nenkin" payment will be trimmed by ¥666 to ¥64,875. The reduction amount will eventually expand to ¥1,675.

This will translate into a cut of ¥2,349, to ¥228,591, per month for a couple comprising a husband who has worked 40 years and a full-time housewife covered additionally by a "kosei nenkin" corporate pension plan. The cut for such a couple will eventually grow to ¥5,900.

Public pension benefits are supposed to be revised every year based on the consumer price index. But the current benefit levels are set 2.5 percent higher than they should be out of consideration for advanced-age pensioners. The proposal aims to dissolve the exceptional treatment. Some ¥7 trillion is estimated to have been paid "additionally" as a result.
I find it surprising that pension benefits in Japan are supposed to be revised every year based on the consumer price index. Moreover, cutting pension benefits, which is supported by all parties, isn't going to ignite inflation. It will add to deflationary headwinds. But the truth is that after a protracted period of deflation, pension benefits should be cut to reflect the decline in the cost of living.

It will be interesting to see how the LDP led by Shinzo Abe will tackle the deflation dragon. While the world is fixated on China's new leadership and the US fiscal cliff (YAWN!!!), looks like the real seismic shift will come from Japan. 

Jesper Bargmann, Head of G11SPOT FX, Asia-Pacific at RBS told CNBC's Capital Connection where he thinks the yuan and yen are heading amid the political changes in the two countries.

Below, Jeremy Stretch, Head of FX Strategy at CIBC, tells CNBC that in a risk averse environment people are still looking for yield and returns - a difficult thing to achieve in the current environment.