Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 16 July 2015 at 2:02 GMT

Bank of Japan holds ground on extraordinary monetary policy

Managing Director / Technical Research Limited
New Zealand
  • There was no change to the BoJ's bond buying program in yesterday’s policy review 
  • Its inflation forecasts were lowered again 
  • The global financial system is at risk if Japan fails with its current policy

By Max McKegg

No one can accuse the Bank of Japan’s policymaking board of lacking resolve. As the months go by and its “holy grail” of 2% inflation remains but a blur on the horizon, Governor Haruhiko Kuroda and his colleagues continue to put on a brave face and act as if everything is going according to plan. It’s not.
Yesterday the board members released their July Outlook for Economic Activity and Prices. Compared to the April forecasts, GDP is now expected to expand in fiscal 2015 at a “somewhat lower” pace, while the rate of inflation “is likely to be about 0% for the time being”. 

 Fielding the blows .. the BoJ needs to deflect concerns to prevent a “deflationary mindset” from taking hold again among business and consumers. Photo: iStock

Not wanting the facts to get in the way of a good story, the board released a statement accompanying their forecasts that said: “Quantitative easing has been exerting its intended effects” and they will continue with QE “as long as it is necessary” to achieve the price stability target of 2% and “make adjustments” to policy as appropriate.
USDJPY hardly moved on the release of the update. Traders seem to think “continue with QE” means no change in policy in the foreseeable future, even though the logical outcome of expanding the monetary base by JPY 80 trillion ad infinitum would leave the central bank with a colossal balance sheet close to the size of the whole Japanese economy, the second largest in the world. 

In such circumstances the idea of expanding QE “as appropriate” seems even more ludicrous, hence the FX market’s reluctance to price it in and take the yen any lower.

BoJ balance sheet
Source: Nordea
To a large extent the bank has boxed itself into a corner and needs to keep putting a positive spin on events to prevent the dreaded “deflationary mindset” from taking hold again among business and consumers. But by its own rules, it now has to follow most other leading central banks and publish quarterly economic updates in which we see what the individual board members actually think is going to happen, not what they wish would happen.
So let’s have a look at their inflation forecasts, the make-or-break benchmark for them and their political overseer Prime Minister Shinzo Abe.

In the chart below of the Consumer Price Index (all items less fresh food) – the BoJ's inflation measure – the vertical white line in the bar chart represents the range of forecasts made by the nine board members, and the “dot” is the median forecast. 

The shaded areas shows the expected error distribution. So for fiscal 2015 (which began on April 1) the median is 0.7% within a forecast range of 0.3% to 1.0%. The medians for fiscal 2016 and 2017 are 1.9% and 1.8% respectively. These numbers are all 0.1% lower than those in the previous set of forecasts issued last April.
Over the last three months, the party line espoused by board members on the speaking circuit has been that the 2% target would be hit sometime in the window of March to September 2016. Good luck with that.

Forecasts for Japan's inflation rate
 Source: Bank of Japan
The small print in yesterday’s updated Outlook shows the assumptions made when compiling the inflation forecasts. One in particular is of interest. It goes like this: “Dubai crude oil prices are expected to rise moderately from the recent 60 US dollars per barrel to about 70 dollars per barrel toward the end of the projection period."
Oil is trading in the low-$50 range as of today. Throughout the big fall in oil prices last year, USDJPY rose to offset the effects on the domestic price and it will need to do so again if the inflation forecasts are to remain credible.

Meanwhile Kuroda has avoided making any comments on the currency since he was criticised by government officials in early June for saying, "If you look at the real effective exchange rate, it shows that the yen is already very weak. Further declines on a real effective exchange rate basis are not likely to happen."
Here is what he was talking about: Japan’s real effective exchange rate is at a multi-decade low.

Japan real effective exchange rate
Source: Bank of Japan
Bank of Japan former deputy governor Kiyohiko Nishimura said today the central bank’s strategy risks sparking an upward spiral in inflation. Clearly the current bank board doesn’t agree with him; in fact, they would give their right arm for any sign of inflation, let alone an upward spiral.

Nevertheless, the projected expansion of the bank’s balance sheet if current policy is maintained will take the financial system into uncharted territory, and if things start to unravel in Japan it will undermine the global consensus that extraordinary monetary policy is the solution to the world-wide economic malaise. 
My latest technical analysis of USDJPY is presented below. If you would like more detailed trading advice on this then let me know.

USDJPY daily chart (click to expand)
USDJPY daily chart

Source: ThomsonReuters. Create your own charts with SaxoTrader; click here to learn more.

– Edited by Gayle Bryant

 Max McKegg is managing director of Technical Research Limited. To follow Max click here, or post your comment below to engage with Saxo Bank's social trading platform.


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