Article / 23 January 2018 at 23:56 GMT

Dissenter at Bank of Japan calls for more easing

Managing Director / Technical Research Limited
New Zealand
  • BOJ holds the line on forward guidance and inflation forecasts 
  • Attempts to control both price and quantity of JGB purchases 
  • Balance sheet almost 100% of GDP 

By Max McKegg

The Bank of Japan held a policy review meeting on Tuesday. Leading into the event there were plenty of misguided expectations that the parameters around the yield curve-control strategy would be altered, indicating a firming of monetary conditions. 

A tinkering of the bank’s regular bond-buying activities a week before had been interpreted as a signal: instead it was a red-herring. 

The super-long end of the yield curve had been flattening – in line with the US curve – and the BoJ simply took the opportunity to reduce purchases in those maturities. 

This was consistent with yield curve control.

In the event the wording of the post-meeting statement was the same as it has been for months. “The Bank will purchase Japanese government bonds (JGBs) so that the 10-year JGB yields will remain around zero percent.”

Bond purchases will continue “at more or less the current pace” – an annual pace of about 80 trillion yen “aiming to achieve the target level of the long-term interest rate specified by the guideline”. 

Traders dropped the 10-year yield a couple of pips to 0.06%. In turn, this was the reason given for the US Treasury equivalent pulling back to 2.61% as the day progressed. 

Chart: BoJ buying Japanese government bonds 
xxx Source: Bank of Japan, Metastock 

It seems the BoJ will persist in trying to control both the quantity of bonds it buys and the price it pays for them. As every ECON 101 student knows, that’s not how the law of supply and demand works - something will have to give. 

As the chart below shows, it’s the quantity commitment that has fallen by the wayside. 

The annual pace of bond purchases has tailed off from the 80 trillion yen target to less that 60 trillion yen. 

On the other hand, as the top chart shows, the bank is prepared to step in and to buy an “unlimited amount” if the yield gets too far away from the “around zero percent” target. 

Clearly they want to have their cake and eat it too. 

xxx
Source: Nordea 
 
As well as making no changes to forward guidance, the bank’s board members issued updated economic projections that were virtually the same as the previous set published last October. 

xxx
 The Bank of Japan is by far the most profligate of central banks when it comes 
to quantitative easing. Photo: Shutterstock

The inflation forecasts are 0.8% (fiscal 2017), 1.4% (2018) and 1.8% (2019). However, risks are seen as “skewed to the downside” because, although the economy is growing at its potential and the unemployment rate is down to 2.7%, the assumption wages and prices will not increase easily has become “deeply entrenched” among firms and households. 

Inflation expectations continue to be formed by a “backward-looking” process where recent inflation is seen to persist into the future. 

Hence “developments in prices continue to warrant careful attention” says the BoJ. This doesn’t sound like a group getting ready to take their foot off the accelerator any time soon. 

If anything, more easing could be on the cards. The vote in favour of holding the line this time around was 8-1, but the dissenter was not in favour of tightening.

Rather, he said that the bank should take “additional easing measures” with a view to “reinforcing the inflation-overshooting commitment”. 

The commitment to continue expanding the monetary base until the observed inflation rate exceeds 2% and stays above the target in a stable manner is unique. 

Most central banks change policy once their forecasts show inflation hitting target within 12 months or so. They don’t wait to see the whites of its eyes. But that’s what the BOJ has committed to do, a point many analysts miss.
 
We will get an inflation update out of Japan on Friday. The headline rate on the Consumer Price Index is expected to hold steady at 0.9% year-on-year while the core rate could tick up marginally to 0.4%. 

The BoJ’s forecast is that the headline rate will reach 2% “around fiscal 2019” 

Spend it like Beckham 

The Bank of Japan is by far the most profligate of central banks when it comes to quantitative easing. 

Its balance sheet as a percentage of GDP is approaching 100%, as shown in the chart below. 

The Swiss Central Bank has reached an even more extreme level but they are not engaging in QE as such, rather selling CHF in exchange for EUR and USD and building up the balance sheet by investing the proceeds in Eurozone and US securities. 

In contrast the US Federal Reserve, European Central Bank and Bank of Japan have bought domestic assets exclusively. 

Chart: Balance sheets of major central banks
xxx
Source; Bloomberg

USDJPY didn’t react much to the BoJ’s decision to sit on its hands. 
 
We could have expected the cross to rally as expectations around tightening came to nothing. 

But something else rather that rate differentials is holding back USD. As the chart below shows, the current situation is similar to the last Fed tightening cycle between 2004 and 2007. 

Then, as now, the USD initially declined when the first couple of hikes were delivered, rallied as the program got into full swing, but went into a sharp decline well before the tightening process ended. 

The same thing has happened this time around. 
xxx
Source: Bloomberg 

--Edited by Adam Courtenay

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