Japan's bumpy road to a recovery

Japan's effort to get its economy moving entered difficult terrain last week. Bond yields rose and stock prices fell. Some promptly declared "Abenomics" - the reforms launched by prime minister Shinzo Abe - a failure. This is ludicrous. Abenomics may fail. But it will not be because bond yields rise or stock markets wobble. On the contrary, bond yields must rise if Japan recovers and the stock market will always wobble. The much-needed Japanese recovery programme will run risks. But last week told us little about them.

True, the yield on 10-year Japanese government bonds was 347 basis points (0.347 percentage points) higher than on May 6. But it was still only 0.91 per cent. This is where it was just over a year earlier. The Nikkei stock market index fell 9.5 per cent between May 22 and 27. But this followed a jump of 80 per cent between November 13 2012 and May 22 2013. Yes, the yen rose a little against the dollar last week, but it is still 23 per cent below its level in early October 2012 (see charts).

How is one to interpret such movements, other than as possibly meaningless short-term fluctuations? Paul Krugman of The New York Times argues that if a fall in the stock market is to be more than sound and fury, it would reflect either fears about weaker than hoped for economic growth, fears about Japanese debt or fears about the resolve of the Bank of Japan. The first would explain the fall in the stock market, but not the jump in bond yields. The second would explain the rise in yields, but not that in the yen. But the third would explain higher bond yields, a weaker stock market and a stronger exchange rate - all in response to a tighter monetary policy than the one now promised. He concluded that the last was the plausible explanation.

Yet this is an analysis of the very short run. In the longer run, bond yields remain well above their trough, which was close to 0.4 per cent and the stock market is up 63 per cent from November's bottom, while the yen has fallen a long way from recent peaks.

This bigger picture suggests that investors still believe that both the BoJ and the government are serious about the new policies they have adopted. The 3.5 per cent annualised economic growth in the first quarter of 2013 may have little to do with new policies. Yet it, too, is cheering.

It is also inevitable that Japan's policy changes will be destabilising. Some board members of the BoJ believe that the policy stance is confusing, because the aim is both to raise inflation and lower interest rates. The volatility of the bond market has also led to criticism of Haruhiko Kuroda, the new governor. Some argue that the losses suffered by banks on their portfolios of JGBs will undermine their ability and willingness to lend into a recovery.

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