Kobe experience offers some comfort for Japan

It's going to be a nervous start to the week in the world's financial markets, as traders and investors try to assess the medium-term impact of Friday's earthquake on Japan's economy.

Most of the early analysis on Friday afternoon assumed the effect of the quake on markets and on Japan's economy would be minimal.

But sentiment darkened over the weekend as reports described the devastation wreaked by the subsequent tsunami, and as it became clear that the fail-safe systems designed to protect Japan's nuclear power stations from earthquake damage had themselves failed at two reactors.

As always when confronted by the unknown and unquantifiable, analysts reached quickly for the history books in search of a useful precedent.

Japan's last big earthquake struck in January 1995 near the port city of Kobe. Although that quake was much smaller in magnitude than Friday's, it was shallower and centred much closer to urban areas. As a result, the physical damage was extensive, with more than 6,400 people killed and many thousands of buildings damaged and destroyed. The cost of the damage is usually put at 10 trillion yen, or US$100 billion at the exchange rate of the day; roughly 2.5 per cent of Japan's gross domestic product at the time.

The reaction of financial markets to the Kobe earthquake confounded many observers. Instead of weakening in response to the dimmer economic outlook, the yen strengthened in the foreign exchange market as Japanese insurance companies repatriated funds to meet expected claims.

Over the following months, the yen climbed almost 20 per cent against the US dollar. On Friday, the yen also strengthened following the quake as traders positioned themselves in anticipation of similar repatriation flows.