Bank of Japan clueless as inflation outlook dims
- USDJPY and JGB yields have been trading quietly over recent weeks
- BoJ intend to conduct “yield curve control”, holding the policy rate at –0.10%
- The AUD is on a roll and received another boost from the RBA's minutes
By Max McKegg
Thursday’s monetary policy statements from the Bank of Japan and European Central Bank were virtually a copy and paste from the previous month’s edition.
In between times EURUSD and Eurozone bond yields had risen, tightening financial conditions, and there was some concern ECB President Mario Draghi would try to talk them down again.
In the event he effectively endorsed the market moves by commenting that present financial conditions remain supportive of reaching the inflation target. This was a green light for traders to give EURUSD another leg up.
In contrast USDJPY and Japanese government bond (JGB) yields have been trading quietly over recent weeks and neither the Bank of Japan’s statement, the updated economic forecasts that accompanied it, nor Governor Haruhiko Kuroda’s follow up press conference suggested any change was on the cards.
when inflation is staring them in the face. Photo: Shutterstock
Once again the new forecasts lowered the inflation outlook. Japan’s Consumer Price Index is expected to increase at an annual rate of only 1.1% this fiscal year, then 1.5% in 2018.
Achievement of the 2% target is expected to be “around fiscal 2019”, that is, sometime in the period April 2019 to March 2020. In the meantime, the core inflation rate – which excludes energy prices – remains close to zero.
Source: AMP Capital
Governor Kuroda looked a tired man at his press conference and he has every reason to feel dispirited.
He has followed a text book approach to inflation targeting and at last has the economy running at an above potential growth rate with unemployment down to 3%.
Theoretically, all the conditions for rising inflation are in place, but theory and practice have not matched.
The main problem is that the attitude of business and consumers to inflation has become “we’ll believe it when we see it” and they are conducting their affairs accordingly.
This means inflation expectations are “lagging somewhat”, as the BoJ euphemistically puts it.
Kuroda’s textbook has a remedy for that affliction as well: a commitment to expanding the monetary base until inflation reaches 2% “in a stable manner”.
The idea is that business and consumers will only change their habits when inflation is staring them in the face.
This is in contrast to standard central banking thinking whereby financial conditions would be tightened in anticipation of inflation reaching target, not when it has already happened.
At the same time as the BoJ will be expanding the monetary base (until at least 2019-2020, based on its latest inflation forecasts) they intend to conduct “yield curve control”, holding the policy rate at –0.10% and the yield on the 10-year government bond at “around zero percent”.
However trying to control both the supply and price of money at the same time is unrealistic - something will have to give.
This chart shows the pace of monetary base expansion (via JGB purchases) tailing off recently as fewer bonds need to be bought to hold the yield at the target level. That’s largely because lower yields in the US have taken the pressure off.
If bond yields in the US start to rise again the Bank of Japan will have to step up its purchases to hold the yield on the 10-year JGB at “around zero percent”.
Their tolerance level on the upside seems to be 0.10%, as shown in the chart below (click to enlarge).
Since yield curve control was introduced a few months back the bank has twice intervened when the yield looked like creeping up over that level, on each occasion expressing determination by offering to buy an unlimited quantity of bonds.
Japanese 10-year government bond chart
A side effect of the yield curve control policy is that USDJPY is tracking closely the yield on the 10-year US Treasury bond, as illustrated in this chart below (click to enlarge).
This situation is likely to continue until the aim of keeping two balls in the air at the same time is put to the test. Will the BoJ stand in the market and offer to buy unlimited quantities of JGBs if US yields start to rise again?
Alternatively, if US yields drop and JGB’s follow suit, will the BOJ start selling some of their holdings to maintain the zero percent target?
US 10-year bond yields
Those are issues Governor Kuroda will be hoping he doesn’t have to face. His term ends in March 2018 and with inflation still likely to be undershooting, the chances are the Abe administration will want to give someone else a go.
Come on Aussie, come on, come on
There was another central bank in the headlines this week: the Reserve Bank of Australia.
The AUDUSD has been on a roll and got another boost when the minutes of the bank’s most recent meeting showed there was discussion of where the neutral policy rate would be if economic conditions returned to normal.
The conclusion was 3.5%, well above the current level of 1.5%. Labor market data released a couple of days later was also supportive, suggesting normality may not be far away.
Technically, AUDUSD has completed a major reversal pattern, in a set up that has similarities with the mid-1980s (see chart below: click to enlarge).
AUDUSD long-term chart
The Aussie has been my favoured trade for subscribers over the past couple of months and my recommended TF trade on Monday (AUDUSD) is developing well. See here. If you would like to receive my latest trading Updates on AUDUSD then let me know.
-- Edited by Adam Courtenay
Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade, then click here to follow him.