So, after weeks of waiting, and with expectations high, new BoJ Governor Haruhiko Kuroda finally got the chance to put his stamp on Japanese monetary policymaking. And he didn’t disappoint, with the Policy Board announcing:
- A pledge to achieve the 2% inflation target ‘at the earliest possible time, with a time horizon of about two years’;
- The introduction of a new “quantitative and qualitative monetary easing” programme, aiming to double the monetary base in two years. In doing so it will;
- Merge the existing asset purchase programme with the rinban market-operation JGB purchases;
- Tear up the long-standing, self-imposed, banknote rule that has theoretically constrained its JGB purchases up to now;
- Increase the stock of its JGB holdings at an annual pace of about ¥50trn, implying a near-doubling of the monthly flow of gross JGB purchases to more than ¥7trn;
- Buy JGBs right across the curve up to 40Y maturities, with the result that the average remaining maturity of JGBs purchased is likely to more than double to about 7 years; and
- Buy more private sector securities, in particular ETFs and J-REITs too.
So, Kuroda’s first meeting was not short on policy announcements. But while Kuroda’s BoJ will be buying significantly more assets, and of longer maturities, than under the previous regime, what has effectively been announced is an (admittedly very large) extension of policy under the previous regime – more QE. The question is, will what has been announced be sufficient to end deflation once-and-for-all?
Well, as the chart below, adapted from the Bank of England, shows QE works through several channels to affect both asset prices and bank lending, boosting wealth, lowering the cost of borrowing and ultimately boosting spending by both households and firms. This eventually closes the output gap, putting upward pressure on inflation. And we have already seen this work in Japan even ahead of the easing on policy announced overnight.
One of the most powerful channels has been via confidence and expectations, where, since the Abe government took over, anticipation of more aggressive stimulus, both monetary and fiscal, has seen significant improvements in both business and household confidence, with evidence that this has already fed through into higher household spending at the start of this year. And, importantly, there has also been an increase in inflation expectations, with financial market expectations of Japanese inflation recently rising (albeit fleetingly) above their German equivalents. Even household inflation expectations have risen. Today’s announcement can only keep that feelgood factor going in the near term.
Meanwhile, asset prices and the exchange rate have also clearly already been positively affected by expectations of more aggressive policy. JGB yields have fallen sharply since the start of the year, with 10Y yields down 23bps and 20Y yields down 36bps even ahead of today’s meeting. And yields across the curve fell dramatically further in the wake of today’s announcement, taking 10Y yields and below close to record lows. That represents a marked easing in monetary conditions. Perhaps more importantly, for Japan’s beleaguered manufacturing sector at least, has been the impact that the new government’s policies have had on the yen, which weakened sharply once again in the wake of today’s announcement.
And with the asset purchases now about to take place, as opposed to just being anticipated, both the portfolio rebalancing and market liquidity channels should be reinforced as the additional money feeds into the system. This should serve to boost equity markets in particular, lowering firms’ funding costs. Finally, this additional money should make lending conditions easier, while increased confidence, improved incentives for banks to lend, and lower funding costs should serve to boost bank lending.
So, far more of the same, particularly in the enormous quantities announced overnight, should produce better economic outcomes. But will it be enough to deliver the 2% inflation target within the next two years? We have our doubts, not least because, as of next year, current plans mean that fiscal policy will be working in the opposite direction to monetary policy. Without a change in direction from the government, the headwinds from fiscal policy risk diminishing the positive effects of monetary easing. There is no doubt that Japan needs to get its fiscal house in order. But it needs to nurse its economy back to health first. Waiting another year or two to do that will hurt an awful lot less than if another recovery is yet again unnecessarily choked off prematurely on the back of concerns over fiscal sustainability. And with the BoJ now committed to purchasing enormous amounts of JGBs, effectively funding the government’s net financing requirement for this year and next, this should provide some comfort to the government that additional short-term fiscal stimulus will not result in the emergence of the (so far mythical) bond vigilantes. Kuroda has shown today that he is willing to act boldly to try and end deflation. The ball is now in the government’s court to provide the economy with the continued support that will augment the BoJ’s actions.
How will the BoJ Asset Purchases work?
Source: BoE and Daiwa Capital Markets Europe Ltd.
Grant Lewis, Head of Research
Chris Scicluna, Head of Economic Research