Why did Japan just have an election and what are its ramifications?
In December 2012, Shinzo Abe was elected to his second term as Japanese Prime Minister and commenced his 'Abenomics' programme in a bid to kick-start the stagnant economy. The programme was based around three so-called 'arrows,' namely monetary easing, fiscal stimulus and structural reforms. Five years on and the economy is starting to look on a firmer footing. Whilst inflation remains muted, economic growth has started to tick up, earnings momentum is coming through and corporate governance appears to be improving.
Earlier this year, Abe's approval rating hit a record low amidst a series of domestic scandals and unpopular policies. However, with the North Korean threat rising over the summer, Abe's firm rebukes and desire to move Japan away from its constitutional pacifism led to a rebound in his popularity. To capitalise on this, and a lack of any real opposition, he called a snap general election in September. He won in a landslide last week, sparking a likely push for a constitutional reform to Japanese pacifism.
Article 9 of the constitution states that Japan cannot have a standing military, with the unofficial understanding that it is allowed an army solely for self-defence. Abe's alleged desire is simply to make this unofficial policy unequivocal. The reform must be passed by referendum and he will face stern support for the well-regarded clause. However, he has cemented his backing in both houses of parliament and will likely be re-elected for another 3-year term as leader of the Liberal Democratic Party (of Japan) next year, giving him until 2021 to implement his desired anti-pacifist reform.
For the most part, his election victory reassures us of the growing attractiveness of Japan as his economic policies should support the market in the coming years. That is, of course, assuming that his constitutional reform agenda doesn't meaningfully detract from his focus on stimulating the Japanese economy. Equity investors have taken notice of these encouraging developments so far which has buoyed the Nikkei index to its highest level since 1996.
Is the European Central Bank set to start hiking rates like other central banks?
Markets have been expecting the European Central Bank ("ECB") to announce a reduction of asset purchases next year since Draghi's speech in June at the Sintra conference in Portugal. The asset purchase programme started in 2015 and was reduced earlier this year by €20bn to monthly bond purchases of €60bn. Throughout this period, there has been a robust recovery in Europe with growth momentum and corporate earnings coming through. Since the start of the year, the euro has appreciated significantly on the back of political risks subsiding and a strengthening European economy. This put the ECB in a difficult position, since even a modest winding down of the bond buying programme may push the currency up further. Inflation still sits below the desired 2% and a further run in the euro would likely push this lower, something the central bank needs to avoid.
This week, Draghi announced that the ECB will reduce monthly net asset purchases from €60bn to €30bn starting from January 2018. The central bank has bought a lot of bonds in the last few years and with a number of these maturities coming due, it is estimated that the reinvestment flow will be on average €15bn a month in 2018. These will not be halted and accordingly, the ECB have made a clear differentiation between balance sheet expansion and ongoing reinvestment flows. As such, policy remains very accommodative, and they indicated that there is potential for the programme to increase in size and duration depending on how economic conditions progress. With asset purchases set to continue, there was no change announced to the current level of interest rates reinforced with a strong reiteration that they will remain at current levels well past the horizon of net asset purchases.
Central banks have become increasingly efficient in flagging monetary policy changes to investors well in advance of any likely moves. Given this, market reactions have been muted for the most part. We expect that central banks worldwide will act in this way going forward in order to manage expectations and avoid any market-moving event like the taper tantrum seen in 2013. When the ECB eventually raises interest rates, this will be on the back of a stable and improving economic outlook.
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