Land Of The Rising Hopes

Is it time to be optimistic about Japan? The answer seems to be yes, as evidence mounts that the economy is about to emerge from its deflation spiral while also benefiting from past corporate reforms. The most important sign: For the first time in more than a decade, private-sector demand is driving growth, instead of exports or government outlays.

Revised data on gross domestic product show the economy grew at a 3.3% annual rate in the second quarter, with solid advances in consumer and capital spending. The gain was triple the initial estimate, and it followed a 5.8% gain in the first quarter.

Both corporations and households are starting to benefit from corporate restructuring. Since the Asian Crisis in 1997, companies have relocated production to other Asian nations, especially China. The moves boosted Japan's profitability but severely crippled its labor markets. Now those profits are powering capital spending, which is generating jobs and income for consumers. Average wages have turned up, reflecting more full-time jobs. In July, available jobs per applicant were the highest since 1992. And both winter and summer bonus payments were up from the year before, the first back-to-back gains since 1996.

Growth Shows New Strength
Crucially, after suffocating under an avalanche of bad loans, banks are breathing again. Banking consolidation and recovery is providing the financial fuel the private sector needs to sustain growth. In August, adjusted bank lending posted its first 12-month rise in years, says the Bank of Japan.

With the domestic economy firming up, so are prices. After five years of deflation, prices have all but stabilized, and the BOJ believes the inflation rate will move into positive territory by the turn of the year. Even so, the central bank is not expected to start lifting interest rates for a long time, since it was severely criticized for tightening too early five years ago when recovery seemed imminent.

If so, that would set up a very accommodative monetary policy for 2006, since with the BOJ holding rates at zero, any pickup in inflation would result in negative real rates. Such a policy alongside solid growth would suggest a bright outlook for assets, from stocks to real estate.

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