Japan's prime minister, Shinzo Abe, has dazzled financial markets with the promise of a three-pronged economic revolution. Photograph: Issei Kato/Reuters
Japan's two-decade fight against rolling recession and permanentdeflation reaches a pivotal moment on Wednesday when Haruhiko Kuroda presides over his first policy meeting as head of the country's central bank.
This is when all the talk about Abenomics is supposed to stop. Financial markets have been dazzled by the pro-growth rhetoric of the country's prime minister, Shinzo Abe, since he was swept back to power with the promise of a three-pronged economic revolution late last year. Now the time is approaching for the Bank of Japan to deliver.
There are three strands to Abenomics – a more activist monetary policy from the Bank of Japan (BoJ), a fiscal boost from increased spending on public works and structural reform to make the economy more productive.
In reality, the BoJ will be expected to do most of the heavy lifting. The new government has announced an expansionary budget but fiscal policy is constrained by the dire state of Japan's public finances. A debt-to-GDP ratio in excess of 200% is the upshot of more than two decades of sluggish growth and repeated attempts to pump-prime the economy. Meanwhile, structural reforms will take time to work, leaving Kuroda with responsibility for boosting short-term growth.
Nonetheless, so far things could hardly have gone better for Abe. The yen has fallen against the dollar, helping boost Japan's export sector. The stock market has soared, and international bodies such as the Organisation for Economic Co-operation and Development have revised up their forecasts for Japanese growth.
Stephen King, the chief economist at HSBC, said the BoJ has been reshaped by the new prime minister. Abe "clearly believes that in its previous guise, Japan's central bank would never deliver the stimulus necessary to drag Japan out of its ongoing deflationary torpor", he added.
Even so, many investors wonder whether this is a classic case of "buy the rumour, sell the fact". Sceptics point to Japan's long struggle to repair damage due to the stock market and real estate bubbles of the 1980s. A quarter of a century on, often quite lengthy periods of strong growth have been choked off by premature policy tightening. Previous governments have promised reflationary action. The markets will want to see if Abe can improve on the aborted recoveries of the mid 1990s and the early 2000s.
Consumers certainly seem to have responded to Abe's bullish talk about ending Japan's lost decades. Spending in the first two months of 2013 was up 3% on the same period of 2012, even though there has been scant evidence of rising wages and salaries.
Japan's companies have so far adopted a much more cautious approach. The country's influential Tankan, a regular survey of business sentiment, showed that investment intentions remain weak, a sign that firms are reserving judgment on the new government's approach.
Despite the need for larger quantities of imported oil after the Fukushima nuclear disaster two years ago, consumer prices have been falling almost continually since the Ggreat recession of 2008-09. Kuroda's challenge is to bring up the rate of inflation to 2%, so that companies and individuals can take advantage of negative real interest rates – borrowing costs lower than the annual increase in the cost of living – and to drive down the value of the yen.
The new governor has three immediate problems to overcome. First, Tokyo is eager to see the yen fall on the foreign exchanges, but the crisis in Cyprus has once again made Japan seem like a safe haven for investors in times of turbulence. Currency movements in recent weeks have not been helpful for Abe and his team.
Second, markets may be expecting a more radical transformation of monetary policy than the BoJ is capable of delivering. It is not as if the central bank has been inactive
. For the past decade it has been trying to end deflation through electronic money creation. Indeed, it was well ahead of the US Federal Reserve and the Bank of England in opting for quantitative easing as a growth-boosting measure.
Finally, the two-day meeting could, in theory, be Kuroda's last. When Abe pushed out the old BoJ governor before his term expired, Kuroda agreed to serve out the last few weeks of his period of office. It ends on 8 April, four days after this week's meeting of the bank's board, and it will require an act of parliament to reappoint him for a full term. That ought to be a formality, although there are analysts who believe he will wait for the next meeting of the BoJ on 26 April before revealing his hand, and in the meantime offer only a "downpayment" on future monetary action.
Julian Jessop, of Capital Economics, said: "We expect the board to announce only small policy changes now, with any more substantial reforms on hold for the second meeting on 26 April. But whatever the precise timing and details, the markets' expectations of the new governor are so high that they will be almost impossible to meet, let alone beat, leaving the risks firmly skewed towards disappointment."
Good arrows?
Prime minister Shinzo Abe announced his three-arrow reform programme for Japan earlier this year.
Fiscal policy was the first arrow to be removed from Abe's quiver. The government hopes to get the economy moving again through a 13.1tn yen supplementary budget with the emphasis on public works.
But value added tax looks set to rise next year to prevent a further increase in Japan's debt mountain.
Monetary policy is the second arrow. The Bank of Japan has already set itself an explicit 2% inflation target and is expected to announce an increase in the amount of Japanese government bonds it will buy. These will be of longer duration than the asset purchases up until now in an attempt to push down long-term interest rates.
Much less is yet known about plans for the third arrow – structural reform. Japan has become keener on free-trade agreements but may baulk at dismantling its agricultural protectionism.