The Bank of Japan: Great Expectations?

So, after weeks of pressure from new Prime Minister Abe, the BoJ today gave him what he wanted: a new 2% inflation target, double the previous ‘1% goal’. This, it pledged to achieve ‘at the earliest possible time’. And in a move towards meeting this target, the BoJ took a leaf out of the Fed’s book and committed to an ‘open-ended’ asset purchase programme once its existing asset purchase plans for 2013 have been completed. So, from 2014, it will purchase ¥13trn of securities per month, up from the average of roughly ¥3.5trn of securities per month it plans to purchase through 2013. But with most of that amount representing the reinvestment of proceeds from maturing securities already purchased, the net increase in the total stock of assets planned for 2014 is a somewhat less striking ¥10trn (about 2% of GDP). That would represent a significant step down from the planned increase of ¥36trn in 2013.

The failure of the BoJ both to add to its planned asset purchases in 2013 and announce more than it did for 2014 was something of a disappointment for the market. But having revised up its growth forecast for FY13 by 0.7ppt to 2.3%, reflecting the recent yen depreciation and the latest fiscal stimulus package, it presumably felt that it didn’t need to do more now. And, in the BoJ’s defence, the BoJ’s new commitment to keep expanding its asset purchases through 2014 is more substantive than the Fed’s ‘open-ended’ commitment given that several FOMC members have questioned whether its own asset purchase programme should continue into 2014. As such, the BoJ’s commitment to carry on easing should contribute to further yen depreciation over coming quarters.

Nevertheless, the BoJ’s new policy moves certainly will not be sufficient to meet the 2% target in the foreseeable future, something it itself admitted when its own updated inflation forecast showed core CPI, when the impact of the planned increase in the consumption tax is removed, remaining below even its previous 1% goal in FY14. And with the BoJ noting that the current low level of inflation expectations is baked in, it cautioned that it will take a ‘considerable’ amount of time for the effects of recent monetary easing to feed through to the economy. It also insisted that its policy decisions will remain conditional on its assessments of the risks, including to financial stability, suggesting (unsurprisingly) that it will continue to prefer incremental changes to policy rather than ‘shock and awe’. And, in contrast to the Fed, it failed to make an automatic link between its economic forecasts and it policy decisions, with a proposal to maintain a virtually zero interest rate until 2% CPI is ‘in sight’ rejected by the Policy Board.

But ‘shock and awe’, rather that ‘steady as she goes’, is what the BoJ will need to do if it is truly serious about delivering on its new target. The chart below suggests that the slide into deflation since the late-1990s has left the link between the amount of spare capacity in the economy and inflation very weak in Japan. So, the Japanese authorities are likely ultimately to have to deliver a very large increase in economic activity to return the economy to sustained 2% inflation, with something much more innovative and substantial than what it announced today required to fundamentally transform those ‘baked-in’ deflation expectations.

So, what we saw today from the BoJ is not the seismic shift in policy that the economy requires to push it onto a new path of higher growth and inflation. And, contrary to the fears of some that have fretted about the total politicisation of the BoJ, it will continue to have significant discretion in the way it sets policy. Certainly, we should not expect any major further changes in the near term while the Bank’s present leadership is in place. But, having acquiesced to a new 2% target and committed to continue easing throughout 2014, today’s announcements represent a significant step forward from the BoJ. So, expect more in due course.

Trade-off between inflation* and the output gap
Trade Off*Measure of core CPI excluding prices of food and energy. Source: Cabinet Office, MIC, Datastream and Daiwa Capital Markets Europe Ltd.

Chris Scicluna, Head of Economic Research

Emily Nicol, Economist

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