I have written about my recent trip to Japan and discussed some takeaways from my conversations with investors on politics and monetary policy. Japan’s economy grew slightly less than expected in this latest 2nd quarter, but still I believe the early indicators of economic data show that Abenomics has been working and is having a real impact on Japan’s economy and inflation trends.

I want to expand on this with anecdotes relating to this fight against deflation, thoughts on the yen moves and the implications of a key debate over the timing of a potential consumption tax increase.

Inflation Indicators Rising

One currency strategist told me he is starting to see inflation pop up in his everyday life. For instance, his barber raised prices on his haircut for the first time in memory—and of course apologized profusely that he had to do it. Raising prices is a foreign concept to many in Japan, and they are just remembering how to do this—as the barber’s deeply apologetic approach showed.

Another investor quipped, “If” people believe there will be inflation, there will be inflation.”

Central to what Abe and the Bank of Japan are attempting is the idea of re-anchoring expectations for future inflation. As inflation expectations change, a self-reinforcing feedback loop is initiated that helps cement those changes. Consumers begin to believe prices will rise in the future, so they go out and consume more today. This higher consumption and demand puts pressure on prices to rise, leading to inflation. As companies benefit from the increased demand, employees get wage increases that in turn support a further rise in inflation.

This self-reinforcing feedback mechanism appears to have been set in motion. The recent inflation reading of +0.4%1 is a sign of progress for a country that has experienced deflationary forces for well over a decade. One factor underpinning some of the inflation has been a weakening yen—given imports of commodities such as oil that are priced in U.S. dollars. And I see this trend of yen weakness continuing.

The Bank of Japan and the Yen

With its monetary policies, the Bank of Japan (BOJ) is clearly becoming one of the most aggressive central banks in the world.

The BOJ balance sheet is expected to triple based on the bank’s currently announced program to double the monetary base over the next two years.2 This balance sheet expansion will be occurring predominantly during a time when the U.S. Federal Reserve is expected to slow its bond-buying program and its own balance sheet expansion. This change in the relative expansion of central bank balance sheets between the U.S. and Japan has the potential to weaken the yen against the U.S. dollar.

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