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April 1 this year will see the anticipated rate of sales tax in Japan rise from 5% to 8% and Prime Minister Shinzo Abe says he will make a decision later this year on whether to increase it further to 10% in 2015. This event has been the talk of the Japanese Yen traders during most of 2013.

Mr Abe’s predecessor, Yoshihiko Noda instigated the stepped rise to help pay for Japan’s burgeoning bill for social welfare – a bill that is likely to grow ever bigger as 40% of the population is expected to be over the age of retirement by 2060.

Guest post by FX Lords

Now, a more serious problem looms as Japan’s debt to GDP ratio rises to 230%, potentially eye-watering but analysts say this ‘headline rate’ shouldn’t be taken as proof that Japan is living beyond its means.

When we look at Japan’s net debt – the debt minus its assets, the figure drops to around 120%. boiling it down further and looking at how much of the GDP goes on servicing the interest, Japan has to expend only 1.2%; now hardly concerning.

The problem will get worse though if the debt increases as a result of the financial pressure from an ageing population which will also impact on the rate of savings in the country.

Abe has several problems to consider as the rate increase looms. Japan is still in the throes of a fifteen year deflationary cycle and despite its best efforts, it is still a problem today. The government has set a target of 2% for inflation but the measures its taking to achieve this target are currently not working.

The increase in sales tax may have the opposite effect, taking money out of the economy, reducing demand and hence prices although the government has promised further tranches of quantitative easing if growth starts to slow.

Growth is vital if Japan is to be able to repay the debt in the future but there are some in the world of economics who feel that even the rise to 8% could be seriously damaging to growth prospects and the desire to exit the country’s deflationary cycle. Whilst the tax increase will feed through into the inflation figures, it will be only be a temporary fillip, what is needed is domestic demand growth which will ultimately boost inflation figures, something which will not happen if the reduction in disposable income is not more than matched by the introduction of liquidity to the market. www.fxlords.com team are expecting high volatility Monday the 31 of March, the 1st of April, which the day of the event and even the day after due to the expected effect on the economy after this raise. Preference will be directed towards long position on the USD/JPY pair but with extreme cautious.