Dollar Bid, But Antipodeans Firm

There are three key developments today. After seemingly spending recent months pursuing a controversial political agenda, Japan’s Abe has returned his attention to the economy to propose corporate tax cuts. This lifted the Nikkei a stunning 7.7%. The UK industrial output and trade figures disappointed. Ideas a month ago that the BOE could hike rates later this year seems quite dated.  The UK economy appears to have lost momentum in late summer.China’s shares advanced for the second day, despite some reports that the government intervention has slackened.   

Abe indicated Japanese corporate tax schedule will by cut by at least 3.3 percentage points, but all of it is not clear water. Some of this reduction has already taken place. At the start of the new fiscal year, starting April 1, it has already been legislated that the corporate tax rate will fall to 31.33% from 34.62%. Perhaps more importantly, Abe recommitted to continuing to bring the corporate tax rate down. 

It will likely boost corporate profitability, which has already been elevated by the decline in the yen.  Rather than seek to exploit the yen’s decline to pick-up market share, Japanese businesses largely let the weaker yen flatter their bottom lines. However, it seems misguided to expect a lower corporate tax rate to boost investment. As we have seen repeatedly, lower interest rates, lower taxes do not boost capex. What boosts capex is prospects for growth. Changing depreciation allowances also may help encourage new investment. 

In addition to the corporate tax cuts, there is also momentum building for a supplemental budget that could be unveiled as early as next month. One government advisor suggested a JPY3.5 trillion (~$28 bln package) could be sufficient. One of the consequences of the tax cut and supplemental budget is that it would seem to reduce the chances of an increase in the BOJ’s asset purchases, even though the BOJ is reportedly considering cutting its inflation forecasts again.