There has been some mixed economic news out of Japan recently. The economy is likely to have contracted in Q4 2010 and deflationary concerns are back after wages fell for the first time in 10 months in December. While this is bad news for domestic consumption, there was some good news in the industrial sector. Manufacturing PMI rose above the crucial 50 mark, which indicates expansion, for the first time since August 2010.

The chart below shows PMI for Japan and the Nikkei (orange line). This chart is monthly and has been normalised, which shows how the two move together. As you can see the PMI and the Nikkei have a strong positive correlation. Thus, a positive PMI suggests gains in the Nikkei.

The closeness of this relationship makes sense. The industrial sector makes up the bulk of the Nikkei, it is more than 2/3 of the index. Falling wages can also help boost margins, so right now domestic economic signals in Japan are positive for the Nikkei. External indicators are also turning positive including strong emerging markets and a pickup in growth in the US, all good news for Japanese exports.

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Indeed, we have seen the Nikkei find strong support at 10,275 - a key support level that goes back to the start of December. Above here we could see back to the 10,500 highs we saw earlier this month. Below here the next support lies at 10,100.

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Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com
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