The Bank of Japan hits the nuclear monetary button

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Three short months after being elected PM, Shinzo Abe looks to have accomplished the first stage of his economic plans to end the fifteen years of deflation and economic stagnation that had devastated the Japanese economy. He has certainly kick-started a new phase of aggressive monetary policy and in the process put the proverbial boot up the Nikkei’s backside!

Japanese PM Shinzo Abe 

Abe has been a zealous advocate of shock, unorthodox, monetary policy as the most powerful weapon to create inflation and it seems he means business looking at the QE measures unveiled last night – watch out “Helicopter” Ben Bernanke!

Initially, his new cabinet head embarked upon the tried and tested verbal intervention – that was enough to drive the yen lower against all its major crosses (and deliver over $1bn to George Soros in correctly predicting this), but then, Abe also persuaded the monetary policy committee to change its stance to a much more aggressiveness one and in the process replaced the BoJ Governor with the dovish Mr. Haruhiko Kuruda. Making his debut intervention last night, Kuruda shocked everyone with his fierce plan towards achieving the stated reflationary goals within an accelerated timescale. I take my hat off to Mr. Kuruda with the Nikkei rising by a tub thumping 6%!

The BOJ’s radical overhaul of its monetary policy involves changing its target for money market operations from the overnight call rate to the monetary base. What this means is that instead of targeting its key interest rate, which is currently set to a ceiling of 0.10%, the BOJ will target the total amount of cash in circulation and held as deposits at the central bank, which are expected to grow from the already record level to an even greater level – a total of 270 trillion Yen (£1.84 tr) by the end of 2014.

The central bank also plans to merge its regular bond buying with the asset purchase program – combining the two with a view to doubling its balance sheet within two years. While the bank purchased 3.4 trillion Yen (£23.2 billion) of bonds on average during the first quarter, it is expected to purchase 7.5 trillions (£47.8 billion) per month until the end of 2014. Kuruda said the central bank will purchase government bonds right along the yield curve and on maturities up to 40 years, engaging in the biggest BOJ easing program ever.

Ben Bernanke

The BOJ has learnt the hard way that “progressive” monetary easing spread over the years is inefficient. Under the previous guard, it was powerless to stop the relentless drive higer of the yen and which robbed the country competitiveness against its regional neighbours such as South Korea and China. Abe is no fool and he has watched closely what everyone’s favourite monetary magician Ben Bernanke has done – understanding that an unorthodox and aggressive stance in monetary policy is the best way of getting results with the US economy powering away in recent years whilst the Japanese economy has remained moribund.

While the S&P 500 has risn 9.4% since the beginning of the year, the Nikkei index that we tipped just at the outset of its move is now up 23.5%, and there is more to come we think. The USD/JPY is also up 11.2% YTD and with the US economy continuing to improve on almost all broad economic measures whilst the BOJ throws the ‘monetary sink’ at the economy, we expect the yen to continue this trend and, probably in the next few weeks pass the 100 mark.

The reaction to the policy announcement was very positive, to say the least, as we can see in the following charts for the Nikkei and the yen.

The Japanese index was trading near the 12,125 mark just before the policy announcement and rose to 12,980, a gain of 855 points, or 7% – one of the largest on record and a true “melt up with the Yen, at the time of writing, also taking out the 97 level.

Abe has well and truly thrown down the Gauntlet to Mr Bernanke! Let the games begin…

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