Japan Stimulus Not Enough to Ensure Economic Recovery

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by: Money Morning
By Kerri Shannon

Japan Monday attempted to halt the surging yen by outlining stimulus measures and easing its monetary policy, but markets failed to respond.

Prime Minister Naoto Kan detailed a plan to implement a new stimulus program by the end of September, and the Bank of Japan announced after an emergency meeting that it would introduce new loan programs to encourage bank lending to consumers.

The yen has climbed more than 10% against the dollar since May, last week hitting a 15-year high of 83.60 per dollar and threatening Japan's export-driven economic recovery. Analysts were skeptical that the moves would do anything to change the currency value or stimulate the stagnant recovery, and said the measures are largely a political attempt to pacify Japanese consumers instead of actually halting the yen's rise.

Investors typically are attracted to the yen as a low-risk investment during economic uncertainty, but the strengthening yen has made Japanese products less competitive overseas. The country also has experienced deflation that has damaged corporate profits and wages.

To increase the money supply, the Bank of Japan is increasing the amount of money available for banks to 30 trillion yen ($351 billion) from 20 trillion yen, and also is starting a six-month loan program in addition to the three-month lending facility already in place. It voted to keep its main overnight target rate at 0.1%.

Although the measures are designed to allow banks to lend more, Japanese consumers and businesses aren't interested in borrowing and banks end up using the extra funds to buy government bonds. This is the second time the bank has extended the loan program, which started as a three-month program lending 10 trillion yen in December, and then increased to 20 trillion yen in March.

The government's stimulus package includes 900 billion yen ($10.8 billion) geared toward protecting jobs and boosting consumer spending. The plan increases career counselors at colleges to help young people find jobs, extends a subsidy program to encourage environmentally friendly appliance purchases, and provides low-interest housing loans for energy-efficient households. The government won't need to borrow more since the money had already been incorporated into the 2010 budget as emergency funds.

The BOJ defended its easing steps, but economists are calling the moves ineffective and weak.

"The government talks of the need for fiscal reconstruction, but then tries to construct an economic stimulus package with tiny fiscal measures and minor, uncoordinated structural reforms," said Jerram, who referred to the loan program and stimulus effort as "largely a charade."

Japan's economy grew only 0.1% in the second quarter, and analysts say the plan does little to address the fundamental problems limiting Japan's growth.

"Japan's economy is in a trap," Masaaki Kaano, a JPMorgan Securities Japan economist, wrote in a note to clients. Kaano said the economy is in a vicious cycle where the yen hurts profits, increases the chance of deflation, raises real interest rates and then strengthens the yen more.

Markets reversed early gains, illustrating widespread skepticism. The Nikkei rallied over 3% early in the day, only to fall back to a 1.8% gain. The yen initially weakened 0.7% against the dollar and then rose to a 0.6% gain.

"The Bank of Japan's extension to its bank-lending program was seen as just too little by many in the market," Marc Chandler, global head of currency strategy at Brown Brothers Harriman, told CNN. "There had been speculation of more strident measures, such as increased buying of Japanese government bonds, to tackle the faltering economy."

Japan's economy has seen consumer prices fall for 17 straight months, and large exporters are considering moving production overseas as the strong yen cuts into profits.

While Monday's move was not aggressive, analysts say further changes in the yen could fuel more significant policy adjustments this fall.

"Today's move is not a bold move," Simon Wong, regional economist at Standard Chartered Bank in Hong Kong, told Reuters. "If the yen continues to appreciate, say it appreciates beyond the 80 level, that could trigger more direct intervention at some point."

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