Japan’s economy remains the third largest in the world, but it is dogged by two decades of deflation and lacklustre economic growth. Japan’s Prime Minister, Shinzo Abe, has vowed to do all in his power to end the deflationary cycle which stifles domestic demand as consumers delay purchases in the knowledge that the goods will be cheaper in the future.

An increase in sales tax has injected some inflation into the economy and caused a consumer spending spike in the first quarter as consumers made purchases ahead of the increase. Domestic consumption accounts for 60% of Japan’s economy.

The Bank of Japan caught markets unaware when it announced that its quantitative easing (QE) measure of purchasing assets would be expanded from its current level of between 60 and 70 trillion Yen to 80 trillion Yen annually (approximately $725 billion).

As with other QE schemes, the aim is to keep borrowing costs low (by providing a strong market for bonds and other securities) whilst injecting liquidity into the financial system through the commissions paid to financial houses making the asset purchases. It is hoped that the increased liquidity will feed through to loans to businesses wishing to expand.

The BOJ initiative was welcomed by the markets and led to the Nikkei closing at 16414 on Friday, a seven year high. On the Forex markets, the effect was to drop the value of the Yen against other major currencies, shedding 3.8% over the course of last week (closing at 112.18 Yen to the Dollar), a trend continuing into this week – at the time of writing; it is trading at 113.3 to the Dollar.

This rate was last seen in December 2007. A weak Yen will make Japanese exports more attractive in importing markets, but will also push up the costs of raw material imports – Japan is still heavily reliant of LPG imports for power generation whilst its nuclear capacity is mothballed.