Investment strategy Asia  

09/08/2016

RETURN OF THE ‘NOTORIOUS BoJ’

The Bank of Japan (BoJ) has disappointed markets by failing to introduce aggressive measures to stimulate growth in the economy and stem the rise of the yen (JPY). Under the weight of their rising currency, many sectors – in particular the country’s exporters – were holding out for a ‘big bang’ monetary policy move that never came.

At its meeting on July 29 2016, the BoJ maintained its target annual increase in the monetary base1 at JPY 80 trillion, and left benchmark interest rates unchanged. It did, however, expand its purchases of exchange-traded funds from JPY 3 trillion to 6 trillion, and boosted its lending programme2 from USD 12 billion to 24 billion. Still, these measures are, in our view, merely minor tweaks to the bank’s monetary easing programme.

The BoJ’s inaction does not mean that its easing efforts are over. Following the policy meeting, BoJ Governor Haruhiko Kuroda reiterated his view that the bank has not reached its limit in asset purchases5 or interest rate adjustments. He also instructed the bank’s board to conduct a comprehensive review of its policy efforts in September, possibly opening the door for the introduction of more fundamental policy innovations in the future. Furthermore, the board’s post-meeting statement hinted that “synergistic effects” between monetary and fiscal policies3 will directly influence their policy views. Last week, prime minister Shinzo Abe’s cabinet introduced a new JPY 28.1 trillion government spending package – of which JPY 7.5 trillion will be spent in the current fiscal year. All of this underscores expectations that Japan’s government and central bank will retain the option to deliver even more coordinated policy action in coming months.

We still believe, however, that the bank has made a mistake in repeatedly issuing stimulus that has fallen short of market expectations and is, thus, rekindling scepticism about its commitment to reflate4 the economy. Credibility has been a difficult currency for the BoJ to obtain, particularly since it had been notorious for its tolerance of chronic deflation. Timid gestures towards stemming sharp appreciations in the JPY, alongside rapidly declining inflation expectations have merely perpetuated such doubts. In terms of its guidance to the market about what its future plans might be, the BoJ board has ostensibly maintained its inflation projections while upgrading its forecast for financial year 2017. But it also highlighted the risk that the 2% inflation target may not be reached within the promised timeframe, thus implicitly accepting the risk that inflation will undershoot and that policy has been ineffective. Admittedly, voter backlash at home and abroad (i.e. US) has narrowed the BoJ’s policy options to asset purchases5 and helicopter money6. The bank, however, seems reluctant to use even these instruments.

While some of the market is counting on the BoJ’s comprehensive review in September to provide the long-awaited catalyst for renewed momentum in Japan and global markets, we note that the calendar will be rather challenging for that to occur. This is because the order in which policy measures are introduced matters a lot. And, in our view, Japan’s policymakers got the initial sequencing wrong. The difficulty of the budgeting process means that Japan will probably not get a second chance to increase its supplementary budget this year. The BoJ and the Abe cabinet, however, have decided not to launch a coordinated monetary and fiscal programme, and instead tried to maintain some distance between them for the time being. As a result, various elements of the upcoming fiscal stimulus package (e.g. consumption vouchers, which some expected to be the main channel for the helicopter money policy) will be designed and understood as conventional spending items (in terms of how they are financed and how they interact with monetary policy). Furthermore, neither the US Federal Reserve (Fed) nor the BoJ has a policy meeting in August, and we do not expect the Fed’s Jackson Hole Economic Symposium (on August 25-26, 2106) to change the policy picture fundamentally – given the repeated failure of the major central banks to introduce a regime change over the last few years. The BoJ will then face a period of exceptional political volatility driven by the US presidential election campaign during September and October. Japanese policy is extremely sensitive to US politics; and a potentially bruising and uncertain presidential campaign could create even more constraints on the BoJ. To put it simply, the BoJ’s next best chance to make meaningful policy changes might be in December or 2017.

In sum, the new easing package from the BoJ was a significant let down for the market. While we still believe that the upcoming fiscal stimulus package will mitigate the downside risks for the Japanese economy, we are no longer convinced that Japan will, in the near term, be able to dispel the uncertainty hanging over the BoJ’s long-term policy strategy. Unless Japan clarifies its policy strategy, we judge that there will be better investment opportunities in other markets. We will, however, continue to monitor the policy discussion for any positive developments that might change our view.

Source of all economic data: Bank of Japan
Source of all market data: Bloomberg, 29 July 2016

*****
1The monetary base refers to the amount of currency supplied by the bank to the economy.
2The lending programme is a temporary measure established by the Bank of Japan to provide loans to support private financial institutions and stimulate bank lending.
3A strategy to synchronise a central bank’s monetary policy (concerned with interest rates and money supply) with a government’s fiscal policy (concerning spending and taxation) to stimulate economic activity
4Reflation is a means of stimulating economic growth following a slowdown, using such tools as interest rate and tax cuts, and changes in the money supply.
5An asset purchase programme involves a central bank purchasing various financial securities on the open market with the aim of encouraging a decline in longer-term market interest rates.
6The ‘helicopter money’ concept suggests that policymakers could seek to stimulate demand in a depressed economy by putting money indirectly into the hands of consumers in the form of central-bank financed government spending.


 

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