The recent Q4-12 GDP print in Japan underscores the mounting pressure on BOJ and Ministry of Finance officials to act decisively on the ongoing strength of the Yen. Japan’s economy slumped to a  2.9% contraction on the year (nominal GDP, NSA) and a 0.77% contraction on the quarter.

This marks the third consecutive quarter in which the Japanese economy has contracted on an annual basis.

Japan’s structural trade surplus is dwindling fast and the external balance has now been in deficit since May 2011 (measured on a 3m mov av). This is also pulling Japan’s overall current account down to levels which are consistently lower than before the crisis which  eats into growth.The overall current account remains in surplus due to a sizable income balance. But the questions are mounting on the sustainability of this external surplus as the Yen keeps on appreciating.

The overriding problem in Japan’s economy is the government debt situation and how Japan will need foreigners to buy Japanese government bonds (JGBs) to finance a current account deficit should such a situation materialize. This would likely lead to significantly higher JGB yields. Our view however is that Japan will follow the path of least resistance which is to allow the central bank to aggressively expand its balance sheet.

We have recently published an in depth analysis on Japan (subscribers only) and our view is that the BOJ will be forced to expand its balance sheet to weaken the Yen and as well as to support fiscal spending by the government.

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