BoJ: The end of the easy bit?

27 April 2015

Chris Scicluna

While it is inevitably set to be overshadowed by the conclusion of the FOMC meeting on Wednesday, this week’s BoJ policy meeting, which concludes the following day, is attracting more interest than such events have done of late. But while some market participants expect additional easing – with their expectations centred on a cut in the interest rate paid on excess reserves, which has been fixed at 10bps throughout the lifetime of QQE – we expect the BoJ to sit tight and leave policy unchanged.

The BoJ seems set to use its updated economic forecasts to make the strongest case for not loosening policy. Admittedly, it will re-state that it expects core CPI to remain near zero for the time being, and will likely revise down slightly its median inflation forecast in FY15 from the 1.0% figure published in January. But Kuroda stated last week that policy will not be amended again simply to respond to a dip in inflation resulting primarily from short-term oil price volatility.

Indeed, the BoJ looks set to keep its faith that the current moderate economic recovery will be sustained. The median GDP growth forecast for FY15 might be revised down slightly from 1½% previously, but a figure above 1½% is likely to be maintained for FY16. So, the BoJ will continue to expect the output gap to close further and keep its fingers crossed that inflation expectations will pick up too, supporting a rising underlying trend in core CPI. As he did last week, Kuroda can be expected to state again that inflation will reach the 2% target ‘in or around’ this fiscal year, while the Board also seems set to maintain its forecast that inflation will average more than 2% in FY16. And despite the likely recessionary impact of the consumption tax hike scheduled for April 2017, it looks set to forecast that underlying inflation will remain close to 2% in FY17 too.

That scenario looks too optimistic to us. But Kuroda will argue that such an outlook does not merit substantive additional easing, the benefits of which might anyway be debatable particularly when set against potential costs of further action, something of which the Policy Board is mindful not least in the context of financial conditions. Equity markets are already riding high without further monetary accommodation, with the Nikkei having recently risen back above 20,000 for the first time in fifteen years. Policymakers, meanwhile, feel uncomfortable about the risks stemming from further sudden yen weakness that might result from new BoJ action. And last week’s Financial Stability Report flagged concerns about possible over-investment by real estate firms, for the first time since 2008, against a backdrop of record-low interest rates.

Conditions in the JGB market call for caution too. Since QQE was expanded at end-October, the bid-to-cover ratios on the BoJ’s purchase operations have taken a notable step down, while secondary JGB market transactions by domestic investors have also dropped. So, the Policy Board might be hesitant to step up the targeted rate of its purchases. It will also continue to fear that a cut in the interest rate on excess reserves would jeopardise QQE by reducing the incentives of institutions to sell JGBs. Indeed, it is for that reason that such a move has yet to be seriously discussed on Kuroda’s watch.

Finally, Kuroda remains wary of the tail risks of a disorderly conclusion to QQE, risks he considers might be heightened by the government’s continued sluggish progress towards fiscal consolidation. With Kuroda concerned that Abe will relax his commitment to balancing the primary fiscal balance by the turn of the decade when he presents his updated budgetary strategy in early summer, this week might seem an unlikely time to provide additional monetary stimulus. Indeed, with signals emerging from the JGB market that it might not stomach a faster pace of monetary expansion, and the BoJ concerned about the end game, we suspect that the next move in monetary policy will eventually be to taper the BoJ’s asset purchases. But, while one external Board member proposed just that earlier in the month, the time for that is highly likely still to be a long way off.

BoJ Rinban operations: Bid-to-cover ratio

BoJ Rinban - 27Apr15

Source: BoJ and Daiwa Capital Markets Europe Ltd.

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