Japan rides the virtuous cycle

No news, it appears, is good news for Japan. The country's stock market and the yen have been heading in the right direction ever since the nuclear threat tit-for-tat between the US and North Korea was taken off the headlines.

The Nikkei-225 index has rebounded by 8.5% from the four-month low plumbed in mid-April and is up 4.1% this year to date. Similarly, the Japanese yen reversed course, resuming its weakening trend versus the US dollar - down 4.2% from the five-month high reached in mid-April - but remains 2.3% stronger against the greenback to date.

The historically strong inverse correlation between the Japanese share market and the currency suggests that given the yen's stronger performance so far this year, the Nikkei-225 index should be weaker (because the benchmark is tilted heavily towards exporters).

The stronger momentum in Japanese equities is, perhaps, explained by the Bank of Japan's (BOJ) growing optimism over the country's economic outlook.

In its 'Summary of Opinions at the Monetary Policy Meeting on April 26 and 27, 2017', released on the 10th of May, the BOJ no longer spoke of an economic "recovery", instead it talked about an economic "expansion" - the most optimistic the BOJ had been in nine years - and of above-potential growth or a positive output gap.

To wit, "Japan's economy has been turning toward a moderate expansion. Although an improvement in domestic demand is not remarkable, the economy is likely to continue growing at a pace above its potential in fiscal 2017 and fiscal 2018, with its underlying trend strengthening."

"Japan's economy is likely to maintain growth at a pace above its potential, mainly through fiscal 2018."

"A positive output gap has been taking hold in Japan with the virtuous cycle led by exports and production becoming firmer."

Markit Economics' latest Japan composite PMI survey gives credence to the BOJ's statement.  While the composite PMI slipped to 52.6 in April (from 52.9 in March), it remains at a 20-month high as the manufacturing expansion gained more momentum (up to 52.7 in April - a 37 month high) and the service sector remaining at its highest level in 42 months despite recording a slight decline to 52.2 in April from 52.9 in the previous month.

The Japanese equity market's positive underpinning does not stop here, it'll continue to be supported by accommodative policy until inflation reaches target.

"...the Bank should continue with the current monetary policy in order to support the virtuous cycle in the economy with the aim of achieving the price stability target of 2 percent."

Despite recent improvements in inflation in the year to March, at 0.2% (headline) and 0.2% (core), they remained way below the BOJ's 2.0% target and as BOJ governor Kuroda himself admits, achieving this is a long way off.

Read more: USBOJPMIBank of JapanKurodaMarkit EconomicsNorth Korea
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