Japanese economy remains fragile

Fresh concerns about the outlook for Japan’s economy and prospects for the wider global economy affected Japanese share prices during August, and the Nikkei 225 Stock Average index fell by 7.5% over the month as a whole.

Growth stocks fared particularly badly and, according to the Investment Management Association, investors continued to avoid Japanese equity funds – particularly those with a bias towards smaller companies, which are viewed as relatively high risk

.Conditions appear to be deteriorating in Japan, where the economy barely grew during the second quarter, expanding by just 0.4% year on year, according to the country’s Cabinet Office. Weak consumer spending, slowing export growth and the effects of a strong yen have all taken their toll and this growth was significantly lower than many analysts had expected.

The Bank of Japan increased its monetary stimulus as the yen hit 15-year highs during the month. Concerns about the strength of the global economic recovery spurred risk-averse investors to seek the perceived “safe havens” of currencies such as the yen – as well as the Swiss franc and the US dollar. Meanwhile, the Ministry of Finance confirmed that nervous Japanese institutional investors had bought the largest amount of foreign bonds in August for any time since 2001.

China superseded Japan to become the world’s second-largest economy during the second quarter of 2010. According to the Cabinet Office, Japan’s gross domestic product for the second quarter amounted to $1.29 trillion (£837bn), compared with growth of $1.34 trillion in China. Japanese Prime Minister Naoto Kan consequently warned that the country’s economy needs to be “closely monitored”.

Deflation continues to be a massive challenge for policymakers in Japan. Consumer prices continued on their downward trajectory during July. Although household spending registered growth of 1.1%, according to the Statistics Bureau, this growth was lower than expected. Meanwhile, machinery orders posted slower-than-expected growth during June, suggesting that many companies are delaying their spending plans.

Towards the end of August, share prices in Japan received a welcome boost from the news that US Federal Reserve Chairman Ben Bernanke was committed to supporting the US economic recovery. Investors were also buoyed by hopes that Japan’s government would not allow the yen’s appreciation to continue unchecked. Japan’s economic growth relies heavily on export activity and, as such, the ongoing strength of the domestic currency poses a real threat to the country’s economic growth.