Japan moves problematic for Korea, Europe?

Japan's quantitative easing and pension asset purchase measures may boost domestic and foreign stocks, but the export of deflation is seen a potential issue, particularly for Korea and Europe.
Japan moves problematic for Korea, Europe?

The Japanese government's twin moves to boost asset purchases and diversify its public pension investments may boost equities in various markets, but some see them putting political pressure on Korea and Europe.

Last Friday the Bank of Japan took the market by surprise when it said it would massively expand its qualitative and quantitative easing scheme, comprising increased purchases of government bonds, exchange-traded funds and real estate investment trusts.

In a related move the same day, the $1.2 trillion Government Pension Investment Fund (GPIF) said it would cut its domestic bond allocation and raise its exposure to domestic and foreign stocks and foreign bonds.

The government's plan is to create upward pressure on asset prices to stimulate consumption, which would in turn fuel inflation.

While fund managers see the dual action as positive for asset prices, they are divided on the risks involved in what they see as experimental policies.

The fact that [Japan's move] is an experiment is itself an enormous risk,” said Al Clark, head of multi-asset at Tokyo-based Nikko Asset Management. “There are so many unintended consequences that come along with these things.”

Increasing the money supply effectively devalues the yen and exports Japan’s deflation, but other countries might not sit idly by as that happens, he warned. Korea’s going to be upset with this – and Europe.” South Korea is the economy most vulnerable to yen weakness, he noted. 

Europe is also vulnerable to such exported deflation, he said, as it too struggles to stave off deflationary pressures. It needs to do something as quickly as possible.”

The ECB has been considering asset purchases along the lines of quantitative easing in the US and has begun to buy covered loans. But government bond buying is off the table for now.

Japan’s move will exert pressure on the ECB to deliver on its commitment to easing, as a weak yen could seriously threaten German exporters’ competitiveness, said Lee Homin, Asia economist at Swiss private bank Lombard Odier.

Subsequently, if Europe engages in competitive devaluation with Japan, deflation would be exported to the US, putting upward pressure on the dollar.

Another potential issue is voter sentiment in Japan turning against reform polices, noted Lee. With a consumption tax rise on the cards for next year and real wages stagnating, the political will driving bold policy could evaporate, he noted.

"No cabinet in the foreseeable future will enjoy as a large a majority to implement aggressive reforms,” added Lee. “2015-16 will be a make-or-break year for the Japanese economy.”

Still, even if improved investor sentiment is short-lived, the benefits of the policies far outweigh the risks at this stage, said Steve Brice, chief investment strategist in Standard Chartered’s wealth management division.

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