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Japan: Can It Emerge From Decades-Long Deflation?

Amanda Cheesley

4 March 2024

Japan has been mired in a deflationary period for the best part of 30 years, but that's changing, so wealth managers think. 

Olivier de Berranger, CIO at France-based (pictured) thinks it is an historic moment for Japan, with structural disinflation from which the country has suffered for 30 years starting to end.

“But the monetary fire is still timid,” de Berranger said. “To prevent it from petering out, the embers need fanning to ensure a roaring blaze. This applies not just to commodities and food prices – which impoverish an importing country – but also to services and especially wages, which should ultimately drive consumer spending.”

“Whatever it takes. The Japanese authorities are all in step – central bank, government and unions,” he continued.

The comments come at a time when a number of asset managers have told this news service that a mix of forces, such as rising global inflation, Japanese corporate governance reforms, and the desire for alternatives to Chinese manufacturing of certain products, have played to Japan's strengths. For years, their companies have held large cash reserves, but governance reforms have emboldened shareholders to demand payouts, leading to higher returns on equity. (See an editorial on the changing trends here.)

Bank of Japan
At its meeting on 31 October 2023, the central bank prolonged its accommodative stance. It held key rates in negative territory (-0.1 per cent), maintaining the upper limit for 10-year yields at 1 per cent, whilst inflation is running at 3 per cent. Real rates – adjusted for inflation – are therefore -3 per cent, and 10-year yields around -2 per cent, a level of stimulus rarely achieved.

“Even more significantly, inflation excluding energy and fresh food – particularly volatile components – has been plateauing at above 4 per cent since the summer. This is a level that is unprecedented since 1981. Seen from this perspective, the stimulus is all the stronger,” de Berranger said.

Although the status of the 1 per cent ceiling on 10-year yields has been tweaked to be slightly less strict, the central bank now considers this a flexible limit, he added. Interventions to prevent it from being exceeded will therefore be less systematic. But the Bank of Japan remains one of the rare central banks – if not the only one – to target an upper limit for this maturity. And we can assume that this level will not be reviewed before, at the earliest, the bank’s publication of inflation expectations for 2026 in April 2024.

While the inflation outlook – excluding energy and fresh food – for 2025 is already around 1.9 per cent and thus close to the long-term target, this time horizon is insufficient to consider that the target has been achieved on a sustainable basis, de Berranger said. “For this, we would need this to be the expected level through to at least 2026. Only if this happens, could the 10-year yield ceiling be cautiously raised or even abandoned, which would be a first,” de Berranger added.

The market has understood the accommodative message, sending the yen above 151 to the dollar, its weakest level since 1990.

“This unique attitude of the Bank of Japan is matched by that of the government,” de Berranger continued. Whilst growth is relatively strong, unemployment still low, and the country has the highest public sector debt to GDP ratio in the world of 255 per cent (like Sudan), the Prime Minister has just passed a new stimulus plan worth over €100 billion (JPY17 000 billion). “He is attempting to mitigate the impact of inflation on households – inflation that he is trying to stoke,” de Berranger said.

De Berranger said wage growth must play its part.

“But these monetary and fiscal efforts will be worth nothing unless wages follow suit. The unions are onto this,” he said.

The largest union in Japan – Rengo – intends to demand a wage increase of more than 5 per cent in annual wage negotiations next spring. But there is no guarantee that this level will be accepted by employers. The Tankan Survey of Enterprises expects only a modest increase in production prices in the coming three years (3.8 per cent cumulative), which leaves little room to increase salaries without severely eroding profits, especially as inflation in the rest of the world is on a falling trajectory.

Although Japan’s specific monetary concerns seem completely different from those in most advanced countries, they are nonetheless very important for the rest of the world, de Berranger said. “In many respects, Japan looks to be a precursor, especially of Europe. Demographic decline, an ageing population, apathetic structural growth, commodities dependence, insufficient inflation, stratospheric public debt, wages in the doldrums, negative key rates – this all mirrors the situation in Europe,” he said.

If Japan’s daring manoeuvre is successful, he believes that it will serve as the mainstay for future action. “If unsuccessful, it will highlight the pitfalls for Europe, although trajectories are already rather similar. The destiny of the two opposite sides of the world appear unified, despite the differences in inflation,” de Berranger added.

Lilian Haag, portfolio manager of global equities at , also believes that the outlook for Japanese markets is more positive. “On the corporate side, we experience that the weak yen strongly supports export-driven Japanese companies,” she said. The return of tourists, who had kept away for a long time, is another driver of the domestic economy. A positive aspect is also the return of inflation, with its favourable impact on the growth of the nominal gross domestic product as well as of corporate profits. “We have not seen such a situation in 20 years,” Haag added.

Investments in Japan are also increasingly seen as an alternative to investments in China. See more here.