The Bank of Japan (BoJ) improved its overall outlook on the Japanese economy Monday. Progress made throughout June had begun to yield signs of recovery after the destruction caused by the earthquake and tsunami last year, the central bank said.

But despite global market relief at Greek election results which saw the majority of the electorate vote for the euro zone’s favoured austerity plan, the BoJ added a warning about the state of global growth into its monthly assessment of the nation’s finances. "Uncertainty over the course of the global economy remains high. Particular attention should be paid to how Europe's debt woes could affect global financial markets," the report said.

This month’s positive assessment followed on from May’s forecast of flat export and output growth and the nation is now expected to outperform the majority of its G7 peers this year, growing by around 2 percent.

Domestic demand is key

"Japan's economic activity has started picking up moderately as domestic demand remains firm, mainly supported by reconstruction-related demand," the central bank said. For the first time in 20 years, the growth experienced by the nation has come from within, as opposed to being a result of its vast export industry.

"Exports are unlikely to be a factor that drags down the economy," said Akihiko Suzuki, chief economist at Mitsubishi UFJ Research and Consulting. "The focus is on whether or not wages will increase" to facilitate a self-sustainable recovery, he added. With Japan's long-running deflation, individual wages were virtually stagnant in 2011, falling 0.2% from a year earlier.”

But despite the domestic strength of this month’s report, the BoJ appear not to be banking on an entirely “export-free” recovery. The report admits that exports are still a key growth factor, representing 15.1 percent of GDP for the fiscal year ended March. And despite solid automobile demand from the US helping to bolster figures this month, slow US growth and the rumbling euro zone crisis have continued to suppress overseas demand.

Fed’s twist again?

A decision is due from the Fed in the next few days over whether engage in a further round of Operation Twist (the swapping of short duration bonds for longer duration ones), a step which could serve to boost consumer spending. If the Fed decide to twist again – so to speak – the chances of a continued improved forecast for Japan should strengthen significantly, economists suggest. “We now expect the Fed to ease policy further at next week’s meeting,” Barclays Capital economist Dean Maki said in a note to clients. “We see a short-term extension of Operation Twist as the most likely outcome.”

Euro zone leaders are also gathering in Mexico today for another G20 meeting which will discuss the possibility of further growth simulating measures via central banks throughout the world. Gary Baker, head of European equities strategy at the Bank of America Merrill Lynch, says his latest research shows 73 percent of respondents to his survey of top economists and analysts now think the ECB will engage in more quantitative easing over the next four months. This figure stands almost 30 percent higher than when the survey was conducted last month.

Despite renewed strength in the Japanese economy, the JPY edged lower across the board Monday morning as risk hungry investors abandoned the safe haven yen on easing concern over Greece. The yen slipped to a 3-week low of 124.68 against the pound on live forex charts, down by more than 2 percent from last Friday's 1-week high of 122.17 after the BoJ left its benchmark rate unchanged. The near-term support for the yen is seen around the 125.0 level.

Sarah Cox. Markets Writer, ForexSpace.com