Koizumania reached a fever pitch on Sunday as the wildly popular Junichiro Koizumi led his unpopular Liberal Democratic Party to an election victory. The prime minister's win could mean many things for Japan's economy, the most immediate being a weaker yen.
Koizumi's ambitious plans to slash government borrowing and force banks to write off bad loans have investors bracing for a drop in Japan's currency. While the prime minister's strategy could pay off in the years ahead, it's sure to cause economic pain in the short-term, by boosting unemployment and depressing growth.
"The initial impact of any reform is likely to be deflationary," says Steven Saywell, a London-based currency strategist at Citibank.
Continuing decline
That helps explain why the yen had its biggest drop in four months and Japanese stocks slid to a 16-year low following the victory of Japan's ruling coalition in Upper House elections. News that industrial production fell 0.7 percent in June, twice as much as expected, didn't help. It was the fourth straight monthly decline and suggested the economy continues to shrink. It contracted 0.2 percent in the first quarter.
Now it's time for markets to contend with the dark side of the "Koizumi Phenomenon." Investors couldn't care less about the personal charisma, mane of unkempt hair and love of rock and roll music that so endeared the 59-year-old to voters. What they do care about is Koizumi's much discussed, but unimplemented economic reform plan. That they've heard far more about it than they've seen isn't inspiring much confidence. Hence the yen's slide.
Since taking office last April, Koizumi has focused on staying there. With the LDP safe for now, Koizumi will try turning economic vision into reality.
"Now for the hard part," says Anne Mills, senior currency economist at Brown Brothers Harriman & Co in New York. "The LDP's win removes one potential barrier to Koizumi's proposed reforms, but bigger ones remain." The biggest are getting changes past a wall of opposition within Koizumi's party and getting the reforms right. Whether markets think Koizumi will pull it off may matter little in the near term.
The mere expectation of reforms is likely to hurt the yen as investors price in a deeper recession and weaker demand for yen-denominated assets. After all, Koizumi has pledged to implement his programs even if they boost unemployment and cause hardship for Japanese households.
All of this could bring the Bank of Japan back into play.
With interest rates at zero percent, BOJ Governor Masaru Hayami has made further money-printing efforts contingent on concrete action by the government. Those steps include forcing banks to write down loans and getting corporations to reduce debt levels.
Once Koizumi starts down that path, the BOJ will come under pressure to make good on its own pledge to increase Japan's money supply.
Koizumi's economic team has dropped few hints it plans to seek a weaker yen to increase trade. That hasn't stopped Finance Minister Masajuro Shiokawa from indicating he'd be comfortable with a lower yen. He said Tokyo should "remain silent" if the currency were to lose value in global markets.
"With fundamentals headed in only one direction, the market interpreted this a green light to sell the yen," says Mansoor Mohi-uddin, a currency analyst at UBS Warburg in Singapore. He thinks the dollar will rise to ?130 year within three months. It's currently at ?125.09.
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