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JPY Rally Likely to be Short Lived

The Bank of Japan disappointed JPY bears with its assessment that it is on track in achieving its 2% inflation target. However more stimulus is very likely probably from late Summer suggesting that the bear market for the Japanese currency will resume soon.

The monetary expansion programme from the BoJ is already substantial running at 60 trillion-70 trillion yen a year (around $580-680 billion) and it has been moving the dial on inflation and GDP growth.

However, once established deflationary forces are hard to shift and they are still very much alive in the Japanese economy.

By Justin Pugsley, Markets Analyst MahiFX.  Follow  @MahiFX  on twitter

But the economy now faces a new challenge. The country’s consumption tax rose to 8% from 5% this month – a move that has been delayed for many years for fear of hurting the economy. And what happens to domestic consumption is important, because it makes up around 60% of GDP.

USD/JPY – could test support at 100, but longer-term target 110

USDJPY April 2014 forex chart for technical analysis trading dollar yen currencies

Demographic deflation

But the much bigger problem in Japan is demographics. It’s population is ageing at an alarming rate with a quarter over the age of 65 and that rises to 38% by 2050. This presents a major deflationary drag on the economy. Over 65s generally tend to spend less than their younger counterparts and claim more healthcare and welfare benefits.

With the old outnumbering children the population is actually set to shrink year on year for decades.

In the absence of mass immigration, something Japan is against, stimulating long-term sustainable GDP growth and inflation will be a major challenge – and one ultimately beyond the powers of the BoJ. The recent up-tick in GDP is therefore likely to be temporary.

There are some solutions that can help such as raising the retirement age and boosting productivity (difficult). Boosting exports can also help, but international trade is a relatively small part of the economy compared with domestic consumption.

The previous governor of the BoJ Masaaki Shirakawa was well aware of the demographic problems and warned about the limits of central bank stimulus programmes.

But Japan has another chronic problem – its debt to GDP ratio is around 230% and the government spends more than it takes in via taxes, meaning the fiscal position is unsustainable.

Given the severe demographic headwinds the real reason behind the BoJ’s actions is probably to ensure the debt is eroded via mild inflation. Also, placing government bonds on the BoJ’s balance sheet with coupons on those bonds paid back to the Japanese Treasury – it effectively lowers the debt burden.

It is very likely that the BoJ will remain very interventionist for many years to come and the outlook for JPY is hardly bullish.

Further reading: USDJPY forecast

Justin Pugsley

Justin Pugsley

MahiFX is headed by David Cooney, former global co-head of currency options and e-FX trading at Barclays Capital and responsible for the award winning e-commerce platform BARX and Susan Cooney, former head of e-FX Institutional Sales in Europe for Barclays Capital. Operating as a market maker, MahiFX provides traders direct access to institutional level execution speeds and spreads through its proprietary-built fully automated pricing and risk management technology, lowering the cost of retail forex trading. MahiFX global operations are headquartered in Christchurch, New Zealand with offices in London, UK with development and support teams in both locations for 24 hour service. The company is regulated by The Australian Securities and Investments Commission (ASIC), Australia’s corporate, markets and financial services regulator. Article by Justin Pugsley, Markets Analyst MahiFX  Follow MahiFX on twitter and on facebook  Disclaimer: This material is considered a public relations communication for general information purposes and does not contain, and should not be construed as containing, investment advice or an investment recommendation, or an offer of or solicitation for any transactions in financial instruments. MahiFX makes no representation and assumes no liability as to the accuracy or completeness of the information provided. The use of MahiFX’s services must be based on your own research and advice, and no reliance should be placed on any information provided or comment made by any director, officer or employee of MahiFX. Any opinions expressed may be personal to the author, and may not reflect the opinions of MahiFX, and are subject to change without notice