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Why Falling Yen May Trigger Rise in Asian Stocks

Gregor Schuster | Getty Images

The Japanese yen has fallen about 6 percent over the past one month, and is expected to weaken further as Japan's new leader Shinzo Abe pushes the central bank to ease more aggressively.

While a weaker yen is expected to increase the Japanese economy's competitiveness, it's also likely to boost sentiment for Asian equities, said analysts.

"The clearest outcome of a weaker yen could be potentially a more robust Japan and that could lift the rest of the region," said Andrew Pease, global head of investment strategy with Russell Investments in Sydney.

"My guess is that the dominant impact of yen depreciation on Asian shares would be positive if it means an end to Japanese deflation and a stronger Japanese economy that is a demand engine for the rest of the region," he added.

Already, sentiment for Asian stocks is more positive since Abe started calling for the Bank of Japan (BOJ) to up their inflation target to 2 percent, with the MSCI Asia Pacific Index gaining about 8 percent since mid-November.

(Read more: BOJ to Mull 2% Inflation Target as Abe Turns Up Heat)

The Nikkei 225, meanwhile, climbed more than 2 percent on Wednesday, breaking through the 10,000-point barrier for the first time since early April. The index has gained about 14 percent since November 15, buoyed by Abe's comments and hopes that a weaker yen will help the country's corporate sector.

"A weaker yen should help Japanese exporters better compete with the Korean and other Asian exporters," said Audrey Goh, investment analyst with Standard Chartered in Singapore. "It should also be positive for Japanese companies who have significant production overseas, as they will be able to bring back better earnings."

The yen, viewed as a safe haven since the global financial crisis, has remained stubbornly strong despite the central bank's attempts this year to expand its asset purchase program.

However, with the victory of Abe's Liberal Democratic Party (LDP) in Sunday's elections, the tide could finally be turning on the yen. The BOJ, which is meeting on Thursday, is expected to ease again and also adopt the new inflation target by January.

(Read more: Just How Low Will the Yen Go?)

"We argue that the probability of Japan adopting QE (quantitative easing)-like policies is increasing," said Herald van der Linde, head of equity strategy with HSBC. "We could see flows out of Japan moving into the rest of Asia, which could have quite an implication for Asian stock markets."

The flip side of a weaker yen, however, could be a withdrawal of investments by Japanese firms from the rest of Asia, Standard Chartered's Goh said. It is early days, but that could be something to watch, she said.

"The strong yen over the last few years has resulted in significant outflow of investments by Japan companies, particularly into Southeast Asia," she said. "Whether this will reverse gradually over time will depend on whether the weakness in yen is sustained, and if there is any structural reform to the domestic economy."

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