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Why Weak Yen Remains Wild Card for Japan's Growth

Monday, 13 May 2013 | 3:44 AM ET
Tom Bonaventure | The Image Bank | Getty Images

Japan will announce its first quarter growth numbers later this week, and there is expectation that the world's third largest economy will deliver a good report card, as "Abenomics" begins to have an impact.

(Watch This: Dangerous to Play Japan on Yen Movements)

Japan's economy is expected to have grown close to 1 percent quarter on quarter in the January-March period, after flat growth in in the previous three months.

A combination of aggressive monetary policy and fiscal stimulus tagged "Abenomics," after Japan's new Prime Minister Shinzo Abe, has lifted sentiment, boosting stocks to record highs and driving the yen lower.

The Japanese currency has depreciated about 30 percent against the U.S. dollar since September last year and was trading around 101.7 on Monday after dipping to a low of 102.15 over the weekend.

(Read More: Conflicting Japan Data—What Are They Telling Us?)

If the yen were to weaken much further domestic households and businesses could start to feel the pressure of increased import costs. Consumers will see a reduction in disposable incomes, while businesses could see their margins hit, said analysts.

"If the yen were to depreciate further to around 120 against the dollar, for example, that level will not only put pressure on households, as their energy costs increase as gas and electricity prices rise, but it will also hurt corporate productivity," said Long Hanhua Wang, Japan economist at RBS.

"Both these elements could push gross domestic product [GDP] down," he added. RBS has forecast Japan's economy to have grown 0.8 percent quarter on quarter over January to March, while a Reuters poll puts growth at 0.7 percent.

Luc Novovitch | Photographer's Choice | Getty Images

Junko Nishioka, chief Japan economist at RBS, said Thursday's GDP figure would represent a "positive win for Abenomics." She said a strong uptick in household consumption, as a result of Abe's attempt to create a "wealth effect" where consumers and investors feel more confident and start spending more, would have been the key driver.

But another rapid depreciation in the currency could pose a threat, said analysts.

"I think at current levels we are still safe but beyond the 110 level it starts getting iffy," said Nizim Idris, head of strategy, fixed income and currencies at Macquarie Group.

"Right now a weaker yen is perceived as a positive as it supports exports and therefore domestic demand. But the harder part is determining when it becomes a burden. "For the weaker yen to become a burden we would need to see it coupled with high inflation of around 5 percent, but right now we are still a long way off," he added.

(Read More: Ssshh! Why Japan Is Keeping Quiet on the Yen)

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