The consumption growth was quite weak and the reason

Jonathan Cavenagh, Currency strategist at Westpac, on Japan economy development

Leaders of China and Japan met and shook hands last week, which was an important and long-awaited step in improving the two-and-a-half-year standoff between the two countries. Moreover, Mr. Abe said after the meeting: “It was the first step towards improving ties by returning to mutually beneficial relations based on common strategic interests”. Taking all this into consideration, what further developments do you expect?

I suppose the geopolitical concerns probably will continue to simmer beneath the surface, hence, there are expectations that it is not going to escalate into anything more significant. Japan and China are very important trading partners, and we still expect that these relationships will grow stronger over the long term. What is interesting to the market today, is the GDP numbers that came from Japan. It was the second consecutive quarterly contraction for Q2 and Q3, which nearly qualifies as a technical recession.

Moreover, the consumption growth was quite weak and the reason behind it was the impact of the tax hike that we witnessed in Q2 of 2014. We believe the further increase in the consumption tax is probably going to be delayed, which generally is a bit more positive for Japanese equity market sentiment. Thus, from the perspective that we have seen a fairly sharp correction lower in Japanese equities, we can assume that it has given a substantial correlation between the stronger equities and the weaker Yen levels.

Japanese Prime Minister will raise the nation’s sales tax next year as planned. He is weighing the need to contain the world’s heaviest debt burden against the risk of derailing Japan’s recovery from two decades of stagnation. Shinzo Abe will base his decision on the health of the economy, which had its sharpest contraction in more than five years after the levy was increased in April. In your opinion, how effective will be this measure?

From my point of view, the risk shows price hike or tax increase gets delayed beyond the first half of the next year. I believe it clearly had more adverse impact on the economy. What is important for the Japanese economy, is the improvements from a fiscal stand point in terms of the Japanese government boosting its fiscal outlook in reducing debts. The critical thing is that the government had to push an inflation and GDP growth on to an improving trend over the past few years, which was obviously taking a setback over the past 6 months.

Japan is looking to move out of deflation where it has been for a long period of time. Thus, it is very important that government maintains positive traction in terms of the outlook for it. We suppose they can keep a very accommodating stance from the monetary policy perspective, and the number one priority for the government should be insuring that the inflation story remains on track. That is why we cannot see any downward shifts to economic growth and, because of that, the consumption tax hike is more likely to be delayed later rather than sooner.