Japan’s economy surprises -- Yen could strengthen

February 21, 2007

Just when it looked like Japan’s economy was going to continue to languish, the government reported a 1.2% growth spurt in the 4th quarter. If it continues at this rate, Japan’s annualized GDP growth is 4.8%, a full point above forecasts. This brings Japan’s economy to a 2.2% real growth rate, above the 1.9% growth in 2005.

This week the Bank of Japan (BOJ) is due to meet, and many economists predict an interest rate hike to .5%, up .25% from current levels which the BOJ set in July.

However, there is unaknowledged pressure on the BOJ from the government of Prime Minister Shinzo Abe, who is more concerned about a return to a moribund deflationary economy than the risk of inflation. This is in contrast to the BOJ’s desire to return to a more balanced economy that includes a higher value for the yen.

What a BOJ rate increase means:
If the BOJ does increase rates at this week’s meeting, it means that the yen will increase in value against the dollar. This will put further downward pressure on the dollar, which has already slid against the euro. A lower dollar value means that the Treasury must raise rates on long-term bonds and notes, which increases interest rates on mortgages. This will further depress the struggling U.S. housing market.

On the other hand, a lower dollar will also increase exports, which will help balance the U.S. trade deficit and possibly even increase GDP growth (although perhaps not enough to offset the decline in the housing market). Another benefit of a lower dollar value is it will decrease the value of the U.S. debt, which is primarily owned by...Japan!

Action steps:
As we said last week, Japan’s economy is getting stronger, and is still an important long-term component of a diversified portfolio. Check with your financial planner to see if now is a good time to shift some of your assets from U.S. to Japan sector mutual funds.

Source: Japan Times Online, “Qualified GDP Growth”, February 17, 2007