Japan: Abenomics deeper in uncharted waters

End October, the Bank of Japan (BoJ) surprised the financial markets by increasing both its asset purchases and the part of JGBs in these purchases. Inflation is likely to increase, but without generating more growth.
In Q3, GDP contracted by 0.4% from the previous quarter, after a 1.9% fall in Q2. The government reacted by calling a snap election on 14 December.
Assuming no change in government policies, we expect GDP growth to slow to around 0.3% both in 20 14 and 2015.
To prevent government spending spiralling out of control, the BoJ will continue to buy treasury bills and JGBs even after reaching the inflation target in 2016 in order to keep interest rates low. The yen is likely to weaken further in the medium term.

Two events in recent weeks have cast doubt on the effectiveness of Japan’s macroeconomic and structural policy framework, the so-called Abenomics. First, end October, the Bank of Japan (BoJ) surprised the financial markets by increasing both its asset purchases and the part of
JGBs in these purchases. The authorities feared that without this policy change, the country could fall back into its “deflationary mind-set”. Second, the impact of the VAT hike on the economy has been much severe than initially thought. In Q3, GDP contracted by 0.4% from the previous quarter, after a 1.9% fall in Q2. The implication is that the economy is in a technical recession. This disappointing result put pressure on the government to postpone the 2-point VAT hike planned for October 2015. The government reacted by calling a snap election on 14 December to reinvigorate its policy.

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