29 Jul 2013
Japan's PM Abe rethinks sales tax hike; inflation case strengthens?
FXstreet.com (Barcelona) - Japan's most significant fiscal reform in years, that is, a planned hike from 5% to 8% in sales tax by April 2014, faces the prospects of being delayed or watered down as concerns mount the tax increase may do more harm than good to the delicate economic recovery in the country.
According to a report from Reuters earlier on Monday: "PM Abe says he will decide in the autumn whether to proceed with the first part of the two-stage plan after gauging the state of the economic recovery, especially GDP data that is due on Sept 9."
Right after claiming victory on the upper house elections last week, Abe showed hesitation about the viability of implementing the planned sales tax increase, as he knows this is a time when any false move in the reforms currently underway could jeopardize the economic recovery.
As Abe stated after winning the election: "It will be a difficult decision. The economy is just starting to recover and now is the best chance for Japan to emerge from deflation. I don’t want to lose this chance. At the same time, markets are watching (our progress) on Japan’s fiscal reform."
On one hand, Mr Abe wants to avoid the raise in sales tax, as it will have a negative impact in consumption growth, however, on the other hand, Abe understands the risks of creating an image of 'distrust' by market participants, as he backtracks one of his most vocal pre-election promised mandate on fiscal reforms .
What does this mean for the inflationary outlook in Japan?
If a cancellation or delay in the sales tax increase is confirmed, what does this mean for the inflationary outlook in Japan? As mentioned last week by IFR Markets Editor Amanda Tan, "a planned sales tax hike poses a downside risk to spending & sentiment, particularly if wages don't start to rise." Amid this scenario, and by connecting the dots in a theoretical cycle, which includes, 'more credit leads to higher spending, which increases sentiment, to ultimately raise salaries', it seems sensible to think that if Abe finally removes the planned sales tax hike from his agenda, inflation pressure may accelerate.
What are the repercussions for the Yen?
The performance of the Japanese Yen is, and will continue to be, mostly dependable on the perception of future monetary policies by the Bank of Japan. Now, if the sales tax increase were to be watered down, seems logical to assume that Japan's alleged inflationary cycle may pick up further momentum, which overtime, if the tendency indicates that the 2% price target is on track, it may suggest that a possible exit strategy from 'ultra loose' policies by the BoJ may be considered.
By maintaining the same threshold of sales tax in Japan, it potentially helps the case for inflation. If this assumptions is correct, and in the medium term more evidence exist about price pressures, the BoJ may have to re-consider its aggressive stance in monetary policies as the price mandate is met, potentially leading to think that a 'tapering' à la 'Japanese' may induce to the market pricing a tighter BoJ, which may prove a *catalyst for the resurgence of the Yen.
In a nutshell, the Yen may enjoy, way down the road, a similar performance to the U.S.Dollar each time the Fed tapering intensifies. With the only difference being, the timetable for the Japanese 'tapering' occurring is still seen as a medium to long term event, thus the relative irrelevance, while the Fed taper is an immediate risk event, leading to much greater levels of volatility in the U.S. Dollar. Bottom line though, a cancellation in the sales tax hike implies chances for a stronger Yen overtime.
According to a report from Reuters earlier on Monday: "PM Abe says he will decide in the autumn whether to proceed with the first part of the two-stage plan after gauging the state of the economic recovery, especially GDP data that is due on Sept 9."
Right after claiming victory on the upper house elections last week, Abe showed hesitation about the viability of implementing the planned sales tax increase, as he knows this is a time when any false move in the reforms currently underway could jeopardize the economic recovery.
As Abe stated after winning the election: "It will be a difficult decision. The economy is just starting to recover and now is the best chance for Japan to emerge from deflation. I don’t want to lose this chance. At the same time, markets are watching (our progress) on Japan’s fiscal reform."
On one hand, Mr Abe wants to avoid the raise in sales tax, as it will have a negative impact in consumption growth, however, on the other hand, Abe understands the risks of creating an image of 'distrust' by market participants, as he backtracks one of his most vocal pre-election promised mandate on fiscal reforms .
What does this mean for the inflationary outlook in Japan?
If a cancellation or delay in the sales tax increase is confirmed, what does this mean for the inflationary outlook in Japan? As mentioned last week by IFR Markets Editor Amanda Tan, "a planned sales tax hike poses a downside risk to spending & sentiment, particularly if wages don't start to rise." Amid this scenario, and by connecting the dots in a theoretical cycle, which includes, 'more credit leads to higher spending, which increases sentiment, to ultimately raise salaries', it seems sensible to think that if Abe finally removes the planned sales tax hike from his agenda, inflation pressure may accelerate.
What are the repercussions for the Yen?
The performance of the Japanese Yen is, and will continue to be, mostly dependable on the perception of future monetary policies by the Bank of Japan. Now, if the sales tax increase were to be watered down, seems logical to assume that Japan's alleged inflationary cycle may pick up further momentum, which overtime, if the tendency indicates that the 2% price target is on track, it may suggest that a possible exit strategy from 'ultra loose' policies by the BoJ may be considered.
By maintaining the same threshold of sales tax in Japan, it potentially helps the case for inflation. If this assumptions is correct, and in the medium term more evidence exist about price pressures, the BoJ may have to re-consider its aggressive stance in monetary policies as the price mandate is met, potentially leading to think that a 'tapering' à la 'Japanese' may induce to the market pricing a tighter BoJ, which may prove a *catalyst for the resurgence of the Yen.
In a nutshell, the Yen may enjoy, way down the road, a similar performance to the U.S.Dollar each time the Fed tapering intensifies. With the only difference being, the timetable for the Japanese 'tapering' occurring is still seen as a medium to long term event, thus the relative irrelevance, while the Fed taper is an immediate risk event, leading to much greater levels of volatility in the U.S. Dollar. Bottom line though, a cancellation in the sales tax hike implies chances for a stronger Yen overtime.