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Japan PM's biggest test on economy still to come

Friday - 4/5/2013, 10:40am  ET

A currency trader checks monitors at a foreign exchange company in Tokyo, Friday, April 5, 2013. Japan's benchmark stock index surged above 13,000 for the first time in more than four years Friday, its second straight day of big gains after the central bank announced aggressive action to lift the economy out of a prolonged slump. The central bank's announcement dragged down the yen, giving a boost to shares of Japan's powerhouse manufacturers. (AP Photo/Koji Sasahara)

ELAINE KURTENBACH
AP Business Writer

TOKYO (AP) -- Prime Minister Shinzo Abe is about to find out that bending central bankers to his will was the easy part of jolting Japan's economy out of its two decade slump.

Since taking office late last year, Abe has sauntered from strength to strength, ticking off the boxes of his policy wish-list while enjoying popularity ratings several times those of his predecessors.

On Thursday, his Liberal Democratic Party claimed its biggest coup since its December parliamentary election win when the central bank surprised markets by overhauling its monetary policy, pledging to double the money supply to achieve a 2 percent inflation target within two years.

The central bank acted "as I had expected," Abe told parliament Friday. "This is truly bold monetary easing on a different level, sending a clear message to markets."

By joining the U.S. Federal Reserve and other major central banks in soaking the economy with money, the Bank of Japan hopes to get corporations and consumers to begin spending more and end a long malaise.

More aggressive monetary easing to end years of deflation is a mainstay of the "Abenomics" platform, along with increased public spending to perk up demand and reforms to improve the long-term competitiveness of the world's third-largest economy.

Whatever deficit spending Japan dares to add to its record public debt already is in the pipeline. Abe has also committed to rebalancing the budget. Now, attention is turning to the toughest part of Abe's program: reforms to make aging Japanese industries and markets more competitive, loosen bottlenecks, and unleash pent-up dynamism and innovation.

Ever since its "Miracle Economy" bubble imploded over 20 years ago, Japan has failed to regain momentum despite lavish government spending and record low interest rates.

Abe's effort to turn the economy around has so far translated into a multi-month rally in the stock market. Investors reacted to the BOJ announcement by pushing the benchmark Nikkei 225 index to its highest level in more than four years Friday.

The Japanese yen, meanwhile, quickly weakened to 96 yen to the U.S. dollar, from around 92 -- in line with Abe's push for a weaker currency that can help make Japanese exports more price competitive in overseas markets, while also raising import costs.

"Changing expectations, creating a more upbeat mood, that in itself is an accomplishment. People are feeling more optimistic and we see it. The stock market is up. The yen is down. Abe's popularity is soaring," said Gerald Curtis, a Japan expert at Columbia University.

Investors will be watching closely, though, for progress in ensuring future growth.

"The question is whether there is the political will and the political ability to get it done. I think Abe's done well but there's a degree of 'irrational exuberance' ... about so-called Abenomics," said Curtis.

So far, economic data have not reflected the optimism seen in the financial markets, though the economy did just barely emerge from recession in the last quarter of 2012.

A quarterly central bank survey released Monday, known as the "tankan," showed business sentiment improving for the first time in nine months, though the gains were weaker than expected. So far, the consumer price index has not budged, despite daily newspaper reports of plans for increases in electricity rates, food prices and other daily necessities.

Abe and fellow LDP leaders must make more headway in reviving the economy before an upper house parliamentary election in July that will determine if they will have a strong enough mandate to pursue other goals, such as politically difficult economic and educational reforms and changes to the constitution to give Japan's military a higher profile.

Getting the economy rumbling again will require consumers to spend more. That depends on a "wealth effect" spilling over from the run-up in prices for shares and other assets, and on convincing people to buy and borrow now, at lower prices, to avoid higher prices later.

Making that will work will depend in part on whether families, whose purchasing power has been declining since 1997, feel they can afford to spend more. Higher wages would help, but salary increases this spring were modest. Companies need to be sure the market is turning around before they will boost hiring and wages.

Recent reports suggest some Japanese are stepping up purchases of luxury products at big department stores, but retail sales figures show no signs of a mass spending spree.

"The evidence is that the wealth effect is much more modest than most people would like to believe," said William Grimes, a professor at Boston University.

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