Japan faces the threat of economic stagnation as panic selling gripped the Tokyo stock market, triggered by economic uncertainty and the Bank of Japan's surprise interest rate hike amid low private spending.
The Nikkei stock index plunged over 2,000 points less than an hour after the 9 a.m. start of trading Friday, with investor sentiment chilled by concerns over a U.S. recession following weaker-than-expected economic data.
The plummet marked the Nikkei's second-largest point drop on record since Oct. 20, 1987, when the benchmark plunged 3,836 points the day after the Black Monday stock market crash.
Shares had extended their tumble from the previous day, where a sell-off was spurred by concerns over Japanese corporate earnings prospects on the back of a stronger yen, which reduces the earnings of automakers and other exporters when repatriated.
The Japanese currency has surged since the BOJ raised interest rates Wednesday, with Governor Kazuo Ueda signaling that the central bank might hike rates again this year at a time when the U.S. Federal Reserve seems on course to cut rates in September.
The yen has climbed by more than 10 versus the U.S. dollar since July 11, when it was in the 161 range and the Nikkei logged a fresh record high above the 42,000 line. On Friday, the Japanese currency strengthened to the 146 zone in New York trading.
"An increasing number of investors will likely become cautious about investing in Japanese stocks," an executive at a European asset management company said.
Inbound tourism, which has surged to record numbers on the yen's depreciation, may also be impacted negatively if the currency continues to rise.
Ueda indicated at a press conference Wednesday that "an additional adjustment to short-term interest rates" may be on the table if efforts to achieve sustainable inflation progress as planned.
While a stronger yen will help keep the prices of imports, such as food and energy, down and ease the burden on households, it may also deal a blow to spending as those who hold stocks see the value of their financial assets diminish.
Private consumption, which accounts for around half of Japan's real gross domestic product, declined for four consecutive quarters through the January-March period. Economic stagnation may become a reality if the trend continues.
While Ueda brushed off concerns about the potential negative impacts of the rate increase, he likely did not anticipate the huge sell-off in the stock market for two consecutive days.
Takahide Kiuchi, executive economist at the Nomura Research Institute and a former BOJ policy board member, forecasted another rate hike in December. However, he added that such a move may be delayed until next year if stocks continue to slide or the yen rapidly appreciates.
Meanwhile, the economic stimulus package being compiled by the government and the ruling Liberal Democratic Party this fall may be large-scale to address the uncertain economic outlook.
"If the economy stagnates, the view that the rate hike was the catalyst will grow stronger within the government and ruling party, making criticism of the BOJ inevitable," a senior government official said.
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