December 27, 2013 7:00 pm JST

Japan to see stronger stocks, weaker yen in 2014

YOICHI NAGAI, NQN senior staff writer

TOKYO -- In 2014, the Japanese economy will likely confront a pair of entirely new worlds -- the world of interest rates and the world of current accounts, where cash flows in and out.

     Investment money flows to countries where monetary easing is being introduced and where management of financial institutions is not worried about as much as in other countries, noted Takashi Kamiya, chief economist at T&D Asset Management. He said that this is a universal understanding among investors who manage their assets on a global basis. Based on this, he said, the Nikkei Stock Average may rise to 22,000 and the dollar may rise to 120 yen in 2014. The prediction will come true only if the real interest rate falls into negative territory, Kamiya added.

     The real interest rate is the nominal interest rate adjusted to remove the effects of inflation. The nominal interest rate is the rate quoted for interest rates on deposits and loans at financial institutions. Declines in the real interest rate tend to stimulate appetite for capital spending in companies and boost consumer confidence.

     Japan's consumer price index for all items excluding food (excepting alcoholic beverages) and energy for November rose 0.6% on the year, according to data released Friday by the Ministry of Internal Affairs and Communications.

     The real interest rate calculated using the CPI and the yield on 10-year Japanese government bonds was 0% for November, down more than 1% from a year earlier, showing that the nation's real interest rate has come close to negative territory.

     If this trend continues, it will be the first time for the real interest rate to fall into negative territory since it did in the mid-1970s when oil crisis occurred, excluding the period from autumn of 1997 through spring of 1998 when financial concern grew after Japan's consumption tax was last raised. Without considering that period, the November figure is at the same level as it was in autumn of 1977. The real interest rate is now approaching the level of a new world.

     What will the world look like when the real interest rate is in negative territory? Toshihiro Nagahama, chief economist at the Dai-ichi Life Research Institute, said, "If I were to describe it in a single phrase, it is a reasonable economy when you make investments through loans." Because yield income from investing in bonds, deposits and savings will be insufficient to make up for inflation, companies are expected to expand their businesses and investors are expected to invest in stocks and other options to achieve higher profitability. Their assets will actually decline unless they do something.

     Meanwhile, the foreign exchange market has a tendency that money flows into currencies of countries with higher real interest rates from those with lower real interest rates. As a result, the Japanese currency is expected to fall further. Japan's real interest rate stood at 0% for November, down from 1.3% at the end of last year, while its U.S. counterpart stood at 1% for November, up from minus 0.1% at the end of last year. The two countries' figures reversed positions.

     As Japan experienced in the past, the U.S. real interest rate had been in negative territory only temporarily back in the 1970s. But the negative figure emerged again during the period from September 2011 through February 2013 after the U.S. Federal Reserve finished its second round of quantitative easing. During this period, effects of the economic stimulus program were observed. In 2012, for example, fixed capital investment climbed 32% on the year, while housing investment was up 30%. On the stock market, the Dow Jones industrial average rose 7% in the same year.

     Declines in the real interest rate are also attributable to inflation that is driven by the weakened yen, which can trace the history of Japan's worsened current account due to increased imports of fuels and other items. Japan had been logging a current-account surplus for more than 20 years before the country started seeing current-account deficit starting in November 2012. In terms of trading money with other countries, Japan is also gradually approaching another new world of deep-rooted current-account deficits.