Three factors that held back Japanese growth in 2014 are already looking more positive for 2015. Fiscal policy is reversing its restrictive stance; exports are rebounding; and wage growth is set to accelerate.

 

As a result, we can be confident that the economy will improve in 2015. Progress on structural reform is less clear, although resolving the TPP (Trans Pacific Partnership) trade talks is a potential positive surprise. (Prime Minister Shinzo) Abe’s re-election gives him the opportunity to push ahead, but it is not clear that the economy is a high priority. At least corporate sector reform – improved governance and lower taxes – is genuine and that should be of interest to markets. It looks like Japan could turn from a macro / policy-driven market to one where micro issues of earnings and corporate performance will dominate.

 

Fiscal policy tightened in 2014 with the 3% rise in the sales tax and this hurt growth more than expected. The decision to postpone the next leg of the sales tax increase from October 2015 to April 2017, together with enacting a moderate-sized supplementary budget, means that fiscal policy will be supportive of growth in 2015, rather than restrictive.

 

This alone would be enough to produce faster growth, but the Bank of Japan’s policy move in late October, and the weaker exchange rate that followed, brings two other positives.

 

The first is that exports and industrial production will again start to move higher, after having been stalled for much of 2014. In fact this already seems to be happening, with companies projecting much stronger output in December and January.

 

The second factor is that companies will see profits step higher as a result of the more competitive exchange rate. At the same time, labour markets continue to tighten, and the ratio of job opportunities to job seekers is at the strongest level since the early 1990s.

 

In the annual wage round in early 2014 the improving labour markets did not generate much growth in base wages, perhaps because firms were not confident enough that the improvement in profitability was persistent. There will not be much doubt by 2015.

 

Higher wages should be positive for economic growth. Companies have not been redistributing much of the improved profitability, either through increased capital spending, or higher dividends. If they pay better wages, this will quickly translate into stronger consumer spending.

 

Wage growth would help to conquer deflation. This could produce a virtuous cycle, as higher inflation means lower real interest rates, which will help to secure economic recovery.

 

The impetus for further USD:JPY strength is likely to come from Fed tightening, rather than the Japanese side. The Bank of Japan will continue to implement its massive balance sheet expansion, but we do not expect more measures, and it could be discussing its exit strategy before the end of the year. Japan is also a major beneficiary of lower oil prices, as energy accounts for 30% of its import bill, and this will decline sharply with lower oil prices and as nuclear reactors come back on line. This could be enough to eliminate the trade deficit, which would limit the potential for JPY weakness. This is the basis for our 12-month forecast of USD:JPY125, rather than a more significant yen decline.