BoJ leaves policy settings steady

Chris Scicluna
Emily Nicol

Equity markets mostly slightly weaker in Asia today
Wall Street traded with a modestly negative tone yesterday with the S&P500 closing down 0.3%. While both the June IP report and the Philly Fed’s manufacturing survey fell short of expectations, the losses on Wall Street were in fact paced by consumer discretionary, infotech and energy stocks (the latter as crude oil extended declines amidst uncertainty about demand in light of rising coronavirus cases in parts of the world as well as expectations of a resolution to the OPEC+ standoff). With Jay Powell reiterating his previous day’s dovish remarks – this time before the Senate Banking Committee – the Treasury market continued to rally, with the 10Y UST closing down 5bps at 1.30%. Despite the decline in yields, a hint of risk aversion provided a degree of buying support for the greenback.

Since Wall Street closed, US equity futures have tracked sideways. However, the Treasury market has traded a little weaker in Europe, with the 10Y UST backing up almost 2bps to close to 1.32% as we write. Against that background, it has generally been a softer day for equity markets in Asia, although losses have generally been moderate. In Japan, where the latest BoJ meeting resulted in no policy changes and largely predictable revisions to the Bank’s growth outlook, the TOPIX has declined 0.4%. The BoJ’s upward revision to the near-term inflation outlook was a little larger than the consensus had expected but the medium-term outlook was unchanged, so likely not explaining modest weakness in the JGB market (which coincided with the lift in UST yields). In mainland China, the CSI300 is down 0.8% but stocks have firmed in Hong Kong amidst reports that firms listing there might not need to seek the approval China’s cyber-security regulator. Markets are also somewhat weaker in South Korea and Taiwan.

In the Antipodes, the focus has again been on New Zealand, with the Q2 CPI rising 1.3%Q/Q – more than double the RBNZ’s most recent forecast – and so driving annual inflation above the Bank’s target range for the first time in 10 years. With broad-based increases paced by the red-hot housing and construction sectors, the market is now pricing a 90% chance of a 25bp rate hike next month and two full rate hikes by the end of the year. So despite the rally in USTs, the 10Y NZGB is little changed today and the Kiwi dollar has firmed. Across the Tasman, despite the widening virus outbreak – with 97 new cases in Sydney and 10 in now locked-down Melbourne – the 10Y AGCB has also underperformed, with yields also little changed today (and stocks similarly). While this follows some outperformance in previous days amidst the virus outbreak, investors might also be wondering whether Australia’s CPI could also reveal a surprise uplift later this month, especially given the similar economic performance of the two countries.

BoJ leaves policy steady, as expected; reduces FY21 GDP forecast, lifts FY21 inflation forecast but still only halfway to target in FY23; green funding measure details released

As widely expected, this month the BoJ’s Board again left all dimensions of its policy unchanged. So its short-term policy rate was left at -0.1% and the 10Y JGB yield target was left at 0%. As usual, there was only one dissenter to the decision – Kataoka, who wants short and long-term interest rates lowered further – with new Board member Nakagawa voting with the majority. In addition, the upper limit for the Bank’s purchases of ETFs (about ¥12trn) and J-REITS (about ¥180bn) was unchanged, as was the Bank’s commitment to purchase, until the end of March, an additional ¥15bn of CP and corporate bonds in total. Also unchanged was the Bank’s commitment to purchase an unlimited amount of JGBs as required to hit its 10Y yield target. As usual, the Bank’s forward guidance continues to indicate that it expects short- and long-term policy rates to remain at current levels or lower, as it will not hesitate to take additional easing measures if necessary (perhaps due to developments in coronavirus delaying prospects for recovery even further than envisaged presently).

Predictably, attention today was principally on the BoJ’s Outlook Report and the details of the “green” fund-provisioning measure that the Bank foreshadowed at the June meeting. Beginning with the former, the updated projections regarding activity conformed largely to consensus expectations. With the economy likely to have performed worse than expected of late due to the ongoing impact of the pandemic on the services sector, the median Board member now expects GDP to grow 3.8% in FY21 – just 0.2ppts less than forecast in April. But with the BoJ maintaining a constructive medium-term outlook, that reduced growth is expected to be recouped the following year, with the forecast for FY22 lifted by 0.3ppts to 2.7%Y/Y. As was the case in April, the median forecast for FY23 is for growth to slow to a still above-trend 1.3%Y/Y. The Bank’s outlook continues to be founded on the reasonable assumption that the negative impacts of coronavirus will wane as vaccination proceeds. Meanwhile, as in April, the economy is expected to be supported by growth in external demand, accommodative financial conditions, the government’s fiscal measures, an intensifying ‘virtuous circle’ from income to spending and an uptrend in investment spending, mainly on machinery and digital technology.

Despite the less positive near-term growth backdrop, the BoJ’s forecast measure of the core CPI (which excludes only fresh food) is forecast to increase 0.6%Y/Y in FY21 – up from just 0.1%Y/Y previously. According to the BoJ, this upward revision – which was larger than the consensus estimate – reflects mainly the impact of the larger than expected rebound in energy prices. It is worth noting that the Bank’s forecast remains based on the current 2015-base index, and that the rebasing of the CPI scheduled for August will result in revisions from January 2021 onwards that are likely to lower recent inflation due to the greater weighting of mobile phone charges in the 2020-base index. Looking further ahead, the median Board member now forecasts core inflation to lift to 0.9%Y/Y in FY22 – just 0.1ppt higher than forecast in April – while the forecast for FY23 was unchanged at 1.0% (even the most optimistic Board member only sees inflation at 1.2%, whereas the most pessimistic member sees inflation at 0.7%). Of course, this would still leave inflation at just half of the current target rate at the end of BoJ Governor Kuroda’s term.

Appropriately, as was the case previously, the Bank notes that the outlook is “highly unclear”, not least due to its dependence on assumptions made about the path of coronavirus and its impact on both domestic and overseas economies. For the purpose of producing its baseline forecasts, the Bank again assumes that the impact of the coronavirus will wane gradually and mostly disappear midway through the forecast period, with no substantial impact on firms’ and households’ longer-term growth expectations or detrimental impact on financial intermediation or stability. Not surprisingly, for the time being it considers that the risks to activity remain skewed to the downside. However, from about the middle of the projection period, the Bank views the risks to activity as generally balanced. Unfortunately, but appropriately given its past undue optimism, the risks to inflation are still considered to be skewed to the downside throughout the forecast period.

Finally, turning to the “green” fund-provisioning measure, titled “Fund-Provisioning Measure to Support Efforts on Climate Change”, the Board agreed a preliminary outline by unanimous vote. The Bank intends to begin the scheme this year and to continue the scheme until 31 March 2031. According to the BoJ, funds will be provided to counterparties that contribute to actions to addressing climate change, which may include investment or loans related to (1) green loans/bonds (2) sustainability-linked loans/bonds with performance targets related to efforts on climate change, and (3) transition finance. Rather than pay a small positive interest rate to institutions that access these funds – as polls indicated a narrow majority of economists had expected – the funds will be provided by the BoJ against pooled collateral at an interest rate of 0%. So instead, to encourage institutions to access the facility, institutions’ macro add-on balances in their BoJ current account (which are exempt from the -0.1% policy rate) will be increased by double the amount of funds received. Finally, while in principle funds will be provided for only one year, rollovers can be made an unlimited number of times while the scheme is running, in effect delivering long-term financing.

Final euro area inflation data for June ahead; no data in the UK today
A relatively quiet week for euro area economic data will end with the final estimates of June inflation. Yesterday we received confirmation that, on the EU-harmonised HICP measure, the Italian headline rate rose 0.1ppt from May to 1.3%Y/Y, while the associated core rate (excluding energy, food, alcohol and tobacco) also rose 0.1ppt to a still-low 0.3%Y/Y. As in Italy, the final estimates of HICP inflation from Germany (down 0.3ppt to 2.1%Y/Y) and France (up 0.1ppt to 1.9%Y/Y) released earlier in the week aligned with their respective flash estimates. So, despite an upwards revision in Spain (up 0.1ppt to 2.5%Y/Y), the final euro area figures will also likely confirm the slight drop in the preliminary headline estimate to 1.9%Y/Y, with the core rate unchanged on the month at 0.9%Y/Y. Within the detail, the preliminary release revealed that energy inflation eased back, dropping 0.6ppt from May’s near-10-year high to a nevertheless still elevated 12.5%Y/Y. But an increase 0.5ppt in non-energy industrial goods inflation to 1.2%Y/Y (partly due to higher clothes prices but perhaps also broader supply-chain pressures) offset a drop of 0.4ppt to 0.7%Y/Y in services inflation (likely related in part to package tours). Beyond inflation, euro area trade data for May, also out today. And not least given the marked impact of supply bottlenecks on autos production, these are expected to reveal that growth in the value of imports exceeded that of exports for a fourth successive month. Consequently, the euro area’s merchandise trade surplus on an adjusted basis is expected to narrow to a twelve-month low of €9.0bn.

Focus turns to the consumer in the US today
Today the focus in the US turns from the factory sector mostly to the consumer, with the highlights being the release of the advance retail sales report for June and the preliminary findings of the University of Michigan’s consumer survey for July. Daiwa America’s Mike Moran forecasts that a drop in auto sales will result in a 0.3%M/M decline in total retail spending, but he expects ex-auto spending to have nudged up 0.2%M/M, half the median forecast on the BBG survey. Meanwhile, he expects that a strengthening labour market and rising stock market will lift the University of Michigan’s consumer confidence index by 4.5pts to 90.0, which if realized would be a post-pandemic high. Attention will also be on that survey’s measures of inflation expectations. News on developments in business inventories during May will complete the week’s economic diary.

Expectations for RBNZ policy tightening next month consolidate after upside CPI shock
Given the abrupt change in the RBNZ’s rhetoric in recent weeks – including Wednesday’s sudden decision to terminate the QE programme – today’s CPI report was always going to be analysed closely. As it turns out, today’s report has consolidated opinion that the RBNZ has overcooked its policy response to the pandemic, and that some paring of that stimulus is appropriate in short order. The headline CPI index increased 1.3%Q/Q in Q2, raising annual inflation to 3.3%Y/Y from 1.5%Y/Y previously – above the upper bound of the RBNZ’s 1-3% target range for the first time since 2011 (when inflation was lifted temporarily by an increase in the sales tax). By comparison, the consensus had expected the CPI to increase 0.7%Q/Q, while the RBNZ’s last published pick was even lower at 0.6%Q/Q. Much of the surprise is due to especially buoyant demand conditions in the construction and housing markets – directly attributable to the RBNZ’s policy settings – but price increases were broad-based.

In the detail, tradeables prices increased 1.7%Q/Q in Q2, lifting annual inflation to 3.4%Y/Y from just 0.5%Y/Y previously. Contributing to this increase – and especially the lift in annual inflation – is the rebound in petrol prices, with the private transport supplies and services group increasing 4.3%Q/Q and 11.3%Y/Y. Vehicle purchase costs also increased a significant 1.9%Q/Q and 7.5%Y/Y. And after previously being depressed by the pandemic, clothing and footwear prices increased 3.3%Q/Q and 4.9%Y/Y. On the other hand, amidst the opening of a travel bubble with Australia, international airfare prices fell 7.6%Q/Q. Non-tradeable prices – which are more reflective of conditions in the domestic economy – increased a very solid 1.2%Q/Q and 3.3%Y/Y, with the annual outcome 0.4ppts above the RBNZ’s May forecast. Unsurprisingly, construction and housing-related price increases were a key driver. The cost of new home construction increased 4.6%Q/Q – with builders citing both strong demand and difficulties obtaining labour and raw materials – and rents increased 0.9%Q/Q.

Importantly, the various analytical and model generated measures of core inflation indicated that the breadth of price increases was wider that just the items mentioned above. Even the 30% trimmed mean increased 1.1%Q/Q and 3.0%Y/Y, while the weighted median increased 0.9%Q/Q and 3.0%Y/Y. Excluding the price of food, household energy and petrol, the CPI increased 1.1%Q/Q and 3.3%Y/Y. As usual, the RBNZ published its own two model-generated filter-based measures of core inflation, which tend to evolve more slowly. These portray core inflation at 2.3%Y/Y and 2.2%Y/Y respectively – up 0.7ppts and 0.2ppts respectively from Q1.

Looking ahead, with pricing pressures continuing to intensify, it is likely that annual inflation will lift further in Q3. So given the likelihood that next month’s labour market report will also show a further tightening of the labour market and a lift in wage growth – in part due to an increase in the minimum wage – the RBNZ is likely to conclude that current policy settings are too stimulatory for the economic conditions. After today’s report, the market is now pricing a 90% probably of a 25bp rate hike in the Official Cash Rate (OCR) at the RBNZ’s next meeting on 18 August. Moreover, the market is fully pricing two 25bps hikes across the remaining three policy reviews this year.

Kiwi manufacturing PMI equally robust in June
In other robust Kiwi news, the BNZ-Business NZ manufacturing PMI increased 1.9pts to 60.7 in May – the fourth highest reading in the 19-year history of the survey and more than 7pts above the historic average for the index. In the detail, the production index edged down 0.3pts to 64.5 while the new orders index edged up 0.1pts to 63.6. The big mover this month was the employment index, which increased 4.5pts to 56.5 – around 6pts above the historic average and thus indicative of an optimistic long-term outlook amongst respondents.

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