USD/JPY Fundamental Weekly Forecast – Pandemic-Led Destruction to Hit Japan’s Economy More Than Expected

A recent sharp deterioration in U.S.-China relations could complicate the outlook for Japan economic growth the rest of the year, as the world’s two largest economies disagree on issues such as trade, technology and the pandemic.

Asked how the conflict between the two nations will affect Japan’s economy, about 90% of economists surveyed by Reuters said it would have a negative impact.

Over 80% of respondents also said Japanese companies would face adverse effects if Washington and Beijing move toward creating their own economic zones, which would mark a retreat of globalization, Reuters said.

“Economic blocs led by those two countries, or de-globalization, would lower global productivity growth. That would have a negative impact on Japan’s potential growth and Japanese firms’ productivity growth,” said Hiroshi Ugai, chief economist at JPMorgan Securities Japan.

Pandemic to Hit Japan’s Economy More than Expected

Japan’s economy will contract more than previously expected and suffer mild deflation during the current fiscal year, analysts predict, underscoring the fragile nature of the recovery from the devastating coronavirus pandemic, Reuters said.

“Economic activity will continue to face restrictions from social distancing measures” needed to prevent the spread of the virus, said Taro Saito, executive research fellow at NLI Research Institute.

“Japan’s economy will likely rebound next fiscal year but won’t recoup the huge losses incurred this year,” he said.

Economy Will Shrink

The economy is forecast to shrink 5.6% in the current fiscal year next March, the poll of 32 economists showed, more than 5.3% contraction projected last month. In a worst case scenario it will shrink 8.0%.

The downgrade came as many analysts revised their forecasts for April-June gross domestic product (GDP) to a 27% contraction – last month’s worst case forecast – from a nearly 24% drop projected in July.

Japan’s economy will grow just 3.3% in the following year beginning in April 2021, the August 4-13 poll showed, unchanged from the previous poll in July.

Deflation Returns

Core consumer prices which exclude volatile fresh food but includes energy costs, will fall 0.3% this fiscal year and rebound just 0.2% next year, according to the poll.

With the economy in deflation and its 2% inflation target proving increasingly elusive, the Bank of Japan’s next move will be an expansion of stimulus, said a majority of those polled.

“The battle against the coronavirus will be a long one. Governments and central banks can’t end steps to combat the pandemic until an effective vaccine becomes available,” said Mari Iwashita, chief market economist at Daiwa securities.

Weekly Forecast

There is nothing in the Reuters’ polls that suggest the Japanese economy is set to recover of the near-term so the Bank of Japan is going to keep interest rates at ultra-low levels. Furthermore, another round of deflation is likely to be a call for action from the BOJ. Meanwhile, in following suit with other major economies, Japan may start to talk about the need for a combination of fiscal and monetary stimulus.

Meanwhile, the Japanese Yen will continue to be a perceived as a carry currency and a safe-haven asset. It’s also going to be controlled by the interest rate differential between U.S. Government bonds and Japanese Government bonds.

Higher U.S. Treasury yields will widen the differential, making the U.S. Dollar a more attractive asset. Lower Treasury yields will drive investors out of the dollar and into the Japanese Yen.