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It is now very clear that the inflation/recession scare in mid-2006 was over done. Consumer prices have since been generally well-behaved, while GDP growth expectations are being revised upward in the US, the Euro area, and now Japan.

If the Economist Poll of economic forecasters for February is any indication, there is still significant potential for upside surprises in Japan's economy, as forecasters had been revising their 2007 growth expectations for Japan downward while US and Euro area growth expectations are being revised upward.

This implies the potential for a Japan "growth scare" to at least temporarily shake out some of the yen bears, even if the BOJ does not move on rates this week or in the foreseeable future.

In our opinion, current views on Japanese personal consumption are too bearish as they are based on faulty Japanese consumption statistics. Japan is currently experiencing one of the tightest labor markets in decades, which will inevitably push up wages from 2007~2008. Moreover, the first wave of retirements by baby boomers (equal to some 8.6% of the labor force) is distorting reported average wage numbers downward.

The GDP surprise has revived interest in the banks and in retail. However, it is an unjustified leap of faith to assume that stronger top-down fundamentals will translate into bank stock and retail stock rallies in equal measure, as demographics, global competition and polarization continue to exert strong pressure for continued consolidation and M&A in these areas.

Among the megabanks, on the earnings fundamentals of the trust banks (such as Sumitomo Trust) are moderately positive. On the other hand, while investors welcome the ongoing consolidation in the department stores with merger talks between Daimaru and Matsuzakaya, department stores as a whole continue to be plagued by adverse demographics, competition from online sales and a proliferation of high-end suburban super malls being operated by real estate developers such as Mitsui Fudosan.

Disclosure: The author is long EWJ.

Source: Will the Yen Bears Be Surprised?