BOJ: Getting With the Program?     

• Last week, there was a lot of speculation about the BOJ�fs next moves. While resolutely ruling out further outright purchases of JGBs and an explicit inflation target as is being demanded by the Hatoyama Administration, the BOJ will reportedly seriously consider additional liquidity provisions to push down Japanese short-term rates. In addition, the MOF has added some JPY5 trillion to its borrowing limit for forex intervention. 
• With 3-month JPY libor rates now again below USD 3-month libor rates, the carry trade borrowing advantage could again shift away from USD as the Fed continues to implement its exit strategy, to JPY or even GBP. What this implies is that the forces are aligning for significant weakness in JPY versus at least USD.   As we have been pointing out, JPY strength versus USD and now Euro has been a significant impediment to a stronger recovery in Japanese stock prices.
• While the BOJ�fs actions, if forthcoming, will work to push short-term rates (and JPY) lower, this alone is insufficient to eradicate entrenched deflation from a continuing JPY30 trillion domestic supply-demand gap and therefore domestic deflation. For Japanese stock investors desperate for some good news, however, last week was a breath of fresh air.
• On the other hand, the Hatoyama Administration�fs ability to implement fiscal stimulus is severely limited by already alarmingly high government debt. The solution to Japan�fs deflationary JPY30 trillion supply-demand gap is therefore more likely to be a combination of a weaker JPY, feed-through effects from an export sector production and profit recovery, and offsetting inflationary pressures from price hikes in steel and other basic materials as the global supply-demand balance for these products tightens.  
• In other words, the way out for Japan is a stronger recovery in global trade?particularly with Asia, and improved profitability on this trade with renewed weakness in JPY exchange rates. Ostensibly, while a renewed commitment to domestic restructuring and consolidation as well as policies to encourage FDI (primarily M&A) are longer-term solutions to the structural malaise in Japan�fs domestic economy, we would not hold our breath in anticipation.

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