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Last July, Japan posted a bigger-than-expected trade deficit, as it widened from June’s revised 60.3 billion JPY figure to a whopping 517.4 billion JPY. This is almost DOUBLE the anticipated 270.0 JPY median forecast from our buddies over at Bloomberg!

So what exactly has caused the widening of the trade deficit?

Remember that a trade deficit means that the value of imports outweigh the value of a country’s exports. Unfortunately, the weakness of the Japan’s trade has been caused by both foreign and domestic factors.

Thanks to the deteriorating European debt crisis and a slowdown in China, external demand fluttered in July. Word on the economic grapevine is that exports fell by a massive 8.1%, with exports to Western Europe and China falling by 28% and 11.9%, respectively. Even more concerning was the drop in electronics, which has traditionally been one of Japan’s strongest export industries!

Domestically, Japan is still suffering from disruptions caused by last year’s earthquake and tsunami. Many Japanese companies have been forced to shut down nuclear reactors due to doubts on their stability. As a result, Japanese companies are struggling to meet their power requirements, and have been forced to tap into pricier alternatives (i.e. oil).

Furthermore, the persistent strength of the yen has also made Japanese products relatively more expensive as compared to its competitors.

After rising steadily early in January, USD/JPY has now dropped back to 2011 levels.

USD/JPY 2012 Performance

Thanks to the strong yen and the deteriorating trade data, the Bank of Japan officials are now facing more pressure to intervene in the markets. In its previous releases, the BOJ had previously said that the underperformance of external demand is a risk to the Japanese economy. Now, market players believe that the “risks” have become “reality.” Yikes!

Analysts believe that the BOJ will loosen its monetary policy in October, when it’s due to release its semi-annual economic outlook. If analysts are right, the move would mark the first monetary easing since April this year, when the BOJ had enlarged its asset purchases by 15 trillion JPY and brought the total purchases to 70 trillion JPY.

Before you price in another round of easing though, you must remember that the BOJ will most likely consider the actions of the other major central banks before it intervenes in markets. And since central banks like the ECB and the Fed are still on a wait-and-see mode, we might not see any real action until the BOJ’s counterparts provide a clearer direction on their policies.