No limits at the BoJ

Emily Nicol
Chris Scicluna

A busy week for the major central banks got underway today with the BoJ significantly upping its support for Japan’s corporate sector and ditching its pretence of an upper limit to its JGB purchases. In particular, the BoJ decided to:

1) Increase significantly its additional purchases of CP and corporate bonds to be conducted in the six months to September by ¥13trn to about ¥15tn. The additional purchases will be split equally between CP and corporate bonds. On top of those extra purchases, the BoJ’s existing holdings of each asset class will be maintained at about ¥2trn and ¥3trn respectively, thus taking its total holdings to ¥20trn. In addition, the issue and issuer limits on its purchases of CP and corporate bonds will be raised significantly. And the maximum remaining maturity of corporate bonds to be purchased will be extended from 3 years to 5 years.

2) Augment the Special Funds-Supplying Operations to Facilitate Financing in Response to the Novel Coronavirus (COVID-19) introduced last month by:

(i) expanding the range of eligible collateral accepted under the scheme;

(ii) increasing the number of eligible counterparties; and

(iii) reducing the disincentive for banks to participate in the scheme by applying an interest rate of 0.1% to the amount of funds drawn under it on their outstanding current account balances held at the central bank.

The BoJ staff were also tasked with coming up with an additional new measure to support SME finance.

3) Make additional purchases of JGBs and T-Bills of a “necessary amount…without setting a limit”, to maintain bond market stability and stabilise “the entire yield curve at a low level” at a time when the government will significantly increase its new issuance. This move, which echoes that of the Fed, allowed it to drop its long-held (but long-undershot) target of ¥80trn for the rate of increase in its stock of JGB holdings. And it committed to purchase JGBs “promptly and appropriately” in the event of a rapid increase in yields.

4) Leave unchanged its purchase targets for the annual increase in its holdings of ETFs and J-REITs, which were increased last month to about ¥12trn and ¥180bn respectively.

5) Closely monitor the impact of Covid-19 and pledge to take additional easing measures if necessary. In his press conference, Kuroda noted that rate cuts were among the possible options. Of course, given concerns about the stability of the financial system, any such move would be accompanied by a further reduction in the share of banks’ excess deposits held at the central bank subject to the negative interest rate.

Asia’s financial markets had already started the week in upbeat mode. But the BoJ’s policy announcement supported that risk appetite, and, with the yen depreciating to its weakest level in almost two weeks, the Nikkei-225 closed up 2.7%. JGBs made gains across the curve, most significantly at the short end (2Y yields down about 2.5bps to close to -0.20%).

USTs reversed earlier losses following the BoJ’s announcement. And while all major European government bonds have also opened higher, BTPs have significantly outperformed, with 10Y yields currently down 10bps. That follows the announcement by S&P after Friday’s market closure that it would not revise down its Italian sovereign rating, despite plans for a significant increase in the government’s deficit target to above 10% of GDP this year. It also follows confirmation from Italian PM Conte that the government will start to relax its national lockdown measures from 4 May, with the Spanish and French leaders also planning to outline exit strategies this week.

Looking ahead, we expect the policy announcements by the Fed (Wednesday) and ECB (Thursday) to bring fewer new initiatives. Indeed, the emphasis in both cases is likely to be on implementing current commitments. Nevertheless, there might well be tweaks made by both central banks to their various purchase and liquidity programmes. Indeed, last week’s announcement by the ECB of an adjustment of its collateral rules to allow the use of securities of “fallen angels” in its liquidity regime might see such paper incorporated in its asset purchase programme. And given the marked deterioration in the economic outlook, and the significant upwards pressure placed on BTPs and other periphery bonds over the past week, we do not rule out an increase in the ECB’s €750bn PEPP purchase ceiling, although that announcement might be more likely to come in the summer.

Data-wise, the highlights include first estimates of Q1 GDP in the US (Wednesday) and euro area (Thursday), which are far more uncertain that usual. Daiwa America Chief Economist Mike Moran expects a drop of 2.5%Q/Q ann. in the US. And we expect a drop of close to 4% or worse in the euro area.

Economic data, etc.

In its updated Outlook Report which accompanied its policy announcements, the BoJ appropriately assessed Japan’s economy to be experiencing an increasingly ‘severe situation’ due to the coronavirus crisis, with significant weakness observed right across the economy. So unsurprisingly, the Policy Board revised down significantly its expectations for GDP growth in both FY19 and FY20, albeit in our view still overly-optimistic.

Its GDP growth forecast of -0.4% to -0.1% for FY19 assumes a maximum contraction of 2¾%Q/Q in Q120. And the range for GDP growth in FY20 of between -5.0% to -3.0% is less marked than that recently predicted by the IMF (-5.2%Y/Y) and was limited by the BoJ’s assumption of a recovery both overseas and in the domestic economy through the second half of the year – which would need to be fairly substantial. Reflecting the government’s economic measures, pent-up demand and base effects, the BoJ forecasts growth to rebound to between 2.8% and 3.9% in FY21 and remain at an above-potential rate in FY22 too.

Admittedly, the BoJ recognised that the economic outlook remains extremely unclear. And risks are firmly skewed to the downside, not least given the unknown profile for the near-term spread and impact of Covid-19. The BoJ also flagged a further risk to its assumptions that there would be no negative impact on firms’ and households’ medium- to long-term growth forecasts. And it recognised that developments in Japan’s financial system would need to be closely watched.

In terms out its inflation outlook, Kuroda acknowledged in his press conference that price momentum has been lost for now. And so, the BoJ revised down its forecast across the projection horizon. In particular, the BoJ’s range for core inflation (excluding fresh foods) is now expected to be between -0.7% and -0.3% in FY20 (compared with 1.0-1.1% in January), 0.0-0.7% in FY2021 (from 1.2%-1.6% previously) and 0.4%-1.0% in FY22. Given the weak growth backdrop, we would expect the outcomes to be closer to the lower bound on each range.

Looking ahead, plenty of new Japanese data for March are due either side of Wednesday’s national holiday. Tomorrow’s March labour market figures are expected to show only a slight rise in the unemployment rate of 0.1ppt to 2.5%. But Thursday’s figures for retail sales and industrial production are set to be exceptionally weak, with both expected to drop by more than 4½%M/M. The advanced Tokyo CPI numbers for April are also bound to post a notable decline, with the core measure excluding fresh food prices expected to drop 0.3ppt to just 0.1%Y/Y. That will partly reflect lower fuel prices. But also excluding all energy prices, the core measure is likely to drop, weighed by the extension of free education to High Schools, lower mobile phone charges and the general weakness of demand.

Euro area:
With the ECB having recently unveiled a wide range of large-scale actions, including its €750bn PEPP asset purchase programme to last through to year-end and a relaxation of collateral rules through to September next year, we think it unlikely that further major policy initiatives will be announced on Thursday. We do, however, expect the ECB to increase the range of assets purchased to include so-called “fallen angels”, to match its recent relaxation of collateral rules. And we would expect the Governing Council to reiterate that, with risks skewed heavily to the downside, it is ‘ready to adjust all of its instruments, as appropriate’.

Of course, with the economic outlook having markedly deteriorated since last month when President Lagarde stressed that the floor to interest rates had not yet been reached, there is a possibility that the ECB will ease policy again. We think, however, that it will wait a little longer to increase the envelope on its PEPP purchase programme. And if it cut the deposit rate below its current level of -0.50%, we would expect the impact of this on the banks to be fully offset by an increase in the tiering multiple.

Thursday will also bring the week’s most noteworthy data release, with the first estimate of Q1 GDP from the euro area and various member states. With output having been significantly disrupted throughout March as lockdown measures came into effect, GDP is expected to have contracted sharply in Q1 – our forecast for a drop of more than 4%Q/Q is slightly steeper than the Bloomberg consensus and would mark the steepest contraction on record. Among country releases also due that day, we anticipate French GDP to have declined by more than 5½%Q/Q, while Italian and Spanish GDP will also contract at an unprecedented pace, close to 5%Q/Q. Thursday will bring GDP data from Austria, Lithuania and Latvia, while figures from Belgium will be published on Wednesday. Of course, while the Q1 GDP figures will look bad, far worse will still be to come in Q2.

Thursday will also bring the flash estimate of April inflation. Against the backdrop of weaker demand and the plunge in the oil price, headline inflation is expected to have fallen sharply again from the 0.7%Y/Y reading in March, possibly to as low as zero for the first time for almost four years. Core inflation will also decline, possibly to around ½%Y/Y from 1%Y/Y previously. However, data collection problems could raise issues.

Meanwhile, March unemployment figures are also due Thursday and, despite the various employment protection programmes across member states, are expected to show an initial jump in the overall unemployment rate last month by 0.4ppt to 7.7%. Official German labour market figures for April will be published on Thursday too, after the weekly updates from the German and French employment agencies earlier in the week. Ahead of this, among other things, April’s European Commission sentiment survey – the most comprehensive guide to euro area economic activity – is due on Wednesday, and is expected to show a drop in the headline economic sentiment indicator to its lowest level since the global financial crisis.

Given the Fed’s massive package of easing measures taken over the past couple of months – including a commitment to make unlimited purchases of USTs and agency MBS if required, a cut the Fed Funds Rate target range to its effective floor, and the launch of its alphabet soup of special lending and purchase facilities – the odd tweak might yet be made on Wednesday. And the policy statement and Powell’s press conference will no doubt be watched closely for any insight into the Committee's updated thoughts on the economy and expectations for possible future adjustments to its various policy initiatives.

In terms of the economic data, the Q1 GDP release, due earlier on Wednesday, will provide some insight into the initial hit to activity associated with Covid-19. While a contraction is certainly on the cards, there is a wide range of forecasts – Mike Moran’s forecast of about -2.5%Q/Q is less pessimistic than the Bloomberg median forecast. Of course, the hit to activity increased significantly towards the end of the first quarter, as will likely be illustrated in the various March data releases including advance goods trade and inventories figures (tomorrow), personal income and spending (Thursday) and construction spending (Friday). And survey results for April, including the Conference Board’s consumer confidence indices (Tuesday), Chicago PMI (Thursday) and manufacturing ISM (Friday), along with the latest vehicle sales figures (Friday), will likely signal a further deterioration in conditions this month. The latest weekly jobless claims figures (Thursday) will likely remain alarming too.

The coming week’s UK data calendar will bring more April sentiment survey results, including perhaps most notably the CBI’s distributive trades survey tomorrow. Following the record decline in Friday’s official March retail sales figures, the survey is expected to show that spending plummeted further at the start of Q2, as the lockdown continued to disrupt activity and weigh even more heavily on demand. Indeed, we would expect to see the headline sales index fall to a record low, below the -55 trough seen during the global financial crisis. Tomorrow will also bring the Lloyds business barometer, which will similarly likely point to a marked deterioration in business conditions in April.

Friday’s final manufacturing PMI will also underscore the significant decline in output over the past month – indeed, the flash estimate showed the output PMI declining a record 27.2pts to a series low 16.6, with the new orders and business expectations indices similarly pointing to bleak near-term outlook. The end of the week will also bring BoE bank lending figures for March. While consumer credit growth will have remained positive, the number of mortgage approvals and associated loans are likely to have fallen significantly as the housing market has effectively come to a standstill.

The April official Chinese PMIs, due on Thursday, will be closely watched for further signs of a return to normality in the mainland economy. In Australia, Q1 inflation data are due Wednesday, with March credit data out the following day and the final CBA manufacturing PMI coming on Friday.

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