Japan Country Risk Report Q3 2016: New research report available at Fast Market Research

We remain convinced that the BoJ and government's inflationary policies are compounding the woes of the economy, rather than improving the growth outlook, and that there is little likelihood of these policies being pared back anytime soon. As such, a sustainable recovery is a long way off, and we caution that the weakness may be only just beginning.

The yen continues to look strong, benefitting from broad-based US dollar weakness, but we are growing increasingly cautious of BoJ intervention given recent appreciation. As such, we are neutral on the yen, but would see any move to JPY105.00/USD as an opportunity to establish a bearish position ahead of the next, and more aggressive, round of monetary stimulus.

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Despite Prime Minister Shinzo Abe seemingly sticking to his plan to raise the consumption tax in 2017, there is still next to no appetite within the government to reduce the deficit, as an offsetting fiscal stimulus package is already in the works. With the budget deficit facing further pressure from a growing defence budget, there is little to be optimistic on regarding Japan's fiscal accounts.

Amid an otherwise poor economic picture, Japan's external accounts are in solid shape, due entirely to strong income account inflows stemming from the country's huge external assets. These external assets, in particular the USD1.25trn held at the BoJ in reserves, may provide an essential safeguard against potential economic and fiscal shocks.

The risk is that Japanese policymakers respond to the still-subdued rate of inflation by enacting more drastic inflationary policies, which could ignite an abrupt change in inflation expectations that would be very difficult to rein in. The longer inflation remains subdued in the near term, the greater the risk of considerable rise over the medium term.

The merger of the opposition Democratic Party of Japan (DPJ) with the smaller Japan Innovation Party (JIP) to form the Democratic Party on March 26 poses a medium term threat to the ruling Liberal Democratic Party (LDP). Despite the Democratic Party's lack of popular support at present, they could be set to capitalise on growing frustration with the LDP's economic stewardship.

Major Forecast Changes

We have revised our forecast for the Japanese yen slightly stronger due to broad-based US dollar weakness, but continue to see the Bank of Japan intervening to prevent significant yen strength. We have also written a new 10-year economic outlook assessing the potential for Japan's already-weak economic growth picture to deteriorate further.

Key Risks

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