The Bank of Japan (BoJ) will be cheered by recent economic data and is, therefore, likely to keep monetary policy on hold at its August meeting.
“With the recent economic data probably having been as strong as it might have hoped, and financial markets having been broadly stable, we expect the Policy Board to do little more than simply restate its pledge to double the monetary base [to Y270 trillion] within two years,” says Grant Lewis, head of research at Daiwa Capital Markets.
Daiwa’s Lewis believes that the chances of the BoJ amending its current policy stance for the remainder of this year are “very slim”, which is in line with the consensus outlook. Such inaction shouldn’t be too concerning, Daiwa says; the BoJ’s balance sheet expansion has barely begun, with only Y25 trillion of JGBs bought, leaving another Y100 trillion of buying to come before the end of 2014.
ABENOMICS SHOWING POSITIVE SIGNS
The policies of Japan’s prime minister Shinzo Abe are starting to gain traction. The consumer prices measure of inflation (excluding fresh food – a measure closely watched by the BoJ) jumped into positive territory in July, rising from 0% to 0.4%; it is an encouraging sign that Abenomics has the mettle to vanquish Japan’s deflationary demons.
Of course, Japan is in the early stages of the war against deflation. And some data remind us that there are still challenges to achieving economic growth. Retail sales in June fell by 0.2% on the month after rising by 1.5% in May; June industrial production also slipped 3.3% on the month, and the composite PMI softened to 50.7 in July, from 52.3 a month earlier.
But BoJ governor Kuroda has taken comfort in the inflation readings, saying that he sees inflation picking up gradually going forward. The governor also states that progress has been made in reducing real interest rates too.
CLUMSY JGB OPERATIONS
The JGB volatility over the last quarter is beginning to ease, largely due to the BoJ’s improved communications and implementation of structural steps, like the flexibility of its market operations.
Investors are buoyed by the yield differential between JGBs and USTs, says Mansoor Mohi-uddin, an analyst at UBS, as shown by Japanese domestic institutions buying Y233bn in overseas bonds last week. This encourages “more risk-seeking behaviour by Japanese investors, including buying higher-yielding foreign currencies.”
JGBs have been remarkably stable over the last month, with yields on the 10-year trading in an 12 basis point range (at the time of print, it is yielding 0.76%). By comparison, over the same period, the US 10-yearhas traded in a 56 basis point range, and the German Bund has traded in a 30 basis point range.
But while volatility is easing, some argue that there is still some scope for the BoJ to improve the mechanics of its monetary policy.
Masayuki Kichikawa, an economist at Bank of America Merrill Lynch, argues that it is important for the BoJ to address this, because volatility may erupt again – not necessarily because of Japan’s own economic fundamentals, but perhaps due to stress in other parts of the global economy.
Without any significant change in policy, dollar-yen is likely to trade within a range between Y98 and Y101, say analysts at UBS, noting that “larger moves in dollar-yen are only likely to come when the Fed signals clearly it will start tapering its asset purchases, or if the BoJ decides to ease monetary policy again.”
Both of these risks are far from imminent. When the Fed will taper is anyone’s guess at the moment. Though in recent days, the Fed’s Lockhart and Evans have suggested that there is a possibility that the Fed could taper in its September meeting.
On the other hand, some analysts believe that the next realistic opportunity the BoJ would have to ease further will be in October, when the Bank publishes its semi-annual economic outlook report; and a change of policy would only be likely if the progress in generating inflation falters.
In the short term, however, Kathleen Brooks, research director at Forex.com, says “the BoJ meeting could be the trigger of a dollar-yen recovery, as the spike higher in the yen may encourage the BoJ to talk down the currency, limiting yen strength.”
In the run up to the meeting, however, the yen has gained against the dollar, sitting around the Y96.75 mark at time of writing – a key two-month channel support as indicated by the 61.8% retracement from June lows.
Analysis of Japan’s monetary endeavours tends to focus on JGBs and the yen. “Rising stock markets globally and sharp BoJ easing at home are both supporting the Nikkei,” says Gareth Berry, a strategist at UBS. In recent months, the Nikkei 225 stock index has been negatively correlated with the yen.
The BoJ dropped its upper-band limit for equity ETF purchases in April, so still has plenty of scope to increase purchases, currently Y1 trillion annually – up 33% over the year. And for comparison, the BoJ currently purchases about as many JGBs in a week (by value) as all of the equity ETFs it has purchased since 2010.
The impact is pretty clear, as seen this week, when the BoJ was in the market buying equity ETFs, which helped prop up dollar-yen .
Berry argues that “these ETF purchases can have a stabilising effect on dollar-yen during the Asia session, especially since operations are conducted sporadically and without warning, and the size is only confirmed after the event.”
With policy widely expected to remain on hold, traders will be looking for comments around the BoJ’s assessment of the Japanese economy, particularly, fiscal policy.
Note: Takashi Nakamichi, a journalist at the Wall Street Journal, says that any comments about fiscal policy are likely to be omitted in the BoJ’s official statement. However, Nakamichi writes “but policy board members may raise it with the government representatives attending those meetings,” and that will mean that it appears in minutes of this meeting (published on 10 September 2013).
The IMF recently urged Japan to keep an eye on its growing public debt mountain, warning that the unprecedented monetary easing may backfire if investors equated it with a monetisation of public debt.
Governor Kuroda has recently sought to pre-emptively calm these fears, saying “if people think this is financing government spending, long-term yields could raise, rendering monetary policy less effective,” adding that “the BoJ is purchasing debt for price stability” only.
Currently, BoJ is buys around 70% of all new Japanese debt issues (on the secondary market), and the IMF thinks that this could push Japan’s debt-to-GDP ratio towards 250% in 2013 – the largest in industrialised nations.
The IMF’s stern tone is due to worries over whether the government can implement the sales tax hike in April 2014 (a rise from 5% to 8%, further rising in October 2015 to 10%), says Nakamichi – a tax that is essential to help Japan tackle its eye-watering debt levels. Any delay could dent the credibility of Abe’s administration, which could weigh on growth expectations.
The sales tax is controversial. Finance minister Taro Aso has backed the policy, but others in the cabinet are more concerned, and these fears from some areas of Japan’s political class are understandable. Last time Japan raised this tax in 1997 a recession followed, and the concern is that this could curb spending, undermining the anti-deflation efforts of Abenomics. A survey of economists by Bloomberg finds that there is a 30% chance that Japan would slip into recession if the sales tax was increased as planned.
The issue of the sales tax has the potential to rock the boat. This week, prime minister Shinzo Abe spoke about potentially shaking up his cabinet towards the end of the year.
Governor Kuroda waded into the debate last week, coming out in favour of the tax hike, saying “the growth of the Japanese economy would not be greatly harmed by a two-stage tax increase”. Typically, Japanese tradition has dictated that only elected officials should strongly enter the debate on fiscal policy.
Traders should look out for any other comments in support of the sales tax from the BoJ; an official decision from Abe’s government is due in the Autumn.
Yogesh Chandarana squawks the market at Live Squawk. Follow Yogesh on twitter: www.twitter.com/Yogi_Chan
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