All eyes on the BoJ's monetary policy annoucement

Chris Scicluna
Emily Nicol

All eyes on the BoJ as market continues to test Kuroda’s resolve to defend his YCC target – might another adjustment be in order?
The week’s main event will undoubtedly be the BoJ’s monetary policy announcement on Wednesday. After Kuroda pulled a surprise last month, doubling the YCC target range for the 10Y JGB yield to +/-0.50%, the outcome this time around is hard to predict with confidence. While Kuroda suggested that there will be no further amendments, the markets have continued to test his resolve, requiring record outright bond purchases to defend the 10Y yield target, as well as record lending of its holdings back to the market (more than ¥7.5trn today alone) to try to support bond market functioning. Indeed, while Kuroda’s justification for December’s policy adjustment was supposedly to help improve the functioning of the JGB market, the market has become increasingly dysfunctional as many participants continue to bet that further adjustments to policy will be made by Kuroda’s successor (due to arrive in April) if not beforehand by Kuroda himself.

Certainly, the JGB curve remains significantly kinked around the 10Y yield, while 10Y swap rate continues to flirt with 1.00% and short-dated OIS point to policy rate hikes before the end of the year. With the Yomiuri newspaper last week having reported that the Policy Board will review the side-effects of its monetary policy and may take further measures to “correct distortions” in the yield curve this week, it would not be a major surprise to see further adjustment to the YCC framework on Wednesday, whether via another increase in the 10Y target, or indeed the abolishment of the target altogether, with or without the introduction of a new target for shorter-dated yields which the BoJ believes are more relevant for inflation and growth.

Nevertheless, Mari Iwashita, the BoJ-watcher for Daiwa Securities in Tokyo, thinks that Kuroda will hold his nerve, leave the current framework intact this week and ultimately also leave it for his successor to disband the YCC framework later in the year. She also thinks the BoJ’s updated Outlook Report will revise up the Bank’s forecast for core inflation to 1.8%Y/Y next fiscal year and 2.0%Y/Y in FY24, with the implied achievement of the target in a couple of years’ time used to justify the current policy stance rather than motivate a further adjustment. Please read a full discussion here from Daiwa Securities’ chief market strategist Eiichiro Tani of issues related to the policy announcement, including how the JGB market might behave in the event of an end to YCC.

Japanese PPI inflation jumped on the back of higher energy prices
Data-wise, today’s Japanese producer goods price inflation surprised on the upside, with the headline rate jumping 0.7ppt to 10.2%Y/Y, the second-highest reading since the early 1980s, due principally to higher prices of electricity and petroleum products, with the respectively annual rates up around 2ppts to 52.3%Y/Y and 7½ppts to 8.0%Y/Y. This will be followed by the national consumer price inflation data on Friday. Our colleagues in Tokyo forecast an increase in the headline national rate of 0.3ppt to 4.1%Y/Y (a touch firmer than the Bloomberg survey consensus), which would be the highest since the early 1980s, due not least to higher energy and non-perishable food inflation. In terms on the growth outlook, the latest goods trade data for December (Thursday), machinery orders figures for November and Reuters Tankan survey for January (Wednesday) will be of note.

ECB account from the December meeting and final December inflation numbers due
The euro area focus this week will be the publication on Thursday of the ECB account from the December monetary policy meeting. While that saw the Governing Council moderate the pace of rate hikes to 50bps, taking the deposit rate to a broadly neutral level of 2.00% and the cumulative tightening since July to 250bps, the ECB’s message was unambiguously hawkish. At the same time, the Governing Council announced that quantitative tightening will start from March onwards. Further details on the debate between the doves and the hawks surrounding these decisions will be closely analysed, as well as any additional clarity on members’ expectations for how much further interest rates might need to rise this cycle. Separately, ECB President Lagarde and Executive Board member Schnabel will speak this week at the World Economic Forum in Davos.

Data-wise, Wednesday will bring final December inflation figures, new car registrations numbers, and construction output data from the euro area. According to the flash data, euro area consumer price inflation slowed 0.9ppt in December to a four-month low of 9.2%Y/Y. The detail confirmed that the drop in inflation was driven by lower energy inflation. But core inflation ticked higher last month, to a new record 5.2%Y/Y, as core goods and services inflation both rose. Final inflation figures from Germany and Italy will be published tomorrow. And German PPI figures (Friday) will be watched for a further easing of price pressures in the manufacturing sector.

UK labour market and CPI data key focuses for the BoE
It will be a busy week for UK releases, with the latest labour market and CPI inflation numbers (tomorrow and Wednesday) of particular interest. Recent leading indicators point to a weakening in labour demand over recent months. And so we expect a drop in employment in the three months to November to push the unemployment rate up to a five-month high of 3.8%. Much might depend on what happens to inactivity, which is likely to remain elevated. And wage growth is expected to remain strong at above 6.0%3M/Y, albeit this would still leave real wage growth firmly in negative territory. Meanwhile, we expect inflation to have eased further in December, with the headline CPI rate down 0.3ppt to 10.4%Y/Y, due principally to declining energy prices. Core inflation is likely to remain stickier, with our expectation for a drop of just 0.1ppt to 6.2%Y/Y. Amid declining real disposable incomes, Friday’s retail sales data look set to show that the trend in household spending remained very weak, with the latest GfK consumer survey likely to show that sentiment remained historically subdued at the start of 2023 too. Separately, BoE Governor Bailey will testify today before the Treasury Select Committee on the December Financial Stability Report.

Chinese GDP expected to have contracted in Q4 amid ongoing Covid-disruption
All eyes in China this week will be on the first estimate of Q4 GDP, along with the December activity indicators. Given persisting widespread Covid-related disruption to activity and a surge in new infections towards the end of last year as restrictions started to relax, GDP is expected to have declined in Q4 – the Bloomberg survey consensus is for a drop of 1.1%Q/Q, to leave the annual rate down 2.3ppts at 1.6%Y/Y, but the range of forecasts is particularly wide not least given question marks about the reliability of these data. A contraction in line with the consensus would leave full-year growth close to 2.7%Y/Y in 2022, down from 8.4%Y/Y in 2021 and only marginally stronger than the 2.2% rate recorded in the first year of the pandemic. The impact of the surge in new Covid cases will be evident in December’s activity figures too, with retail sales expected to have plunged 9.0%Y/Y, while growth in IP is forecast to have slowed to just 0.2%Y/Y.

US PPI, retail sales and industrial production data in focus on Wednesday
After US markets re-open tomorrow after today’s national holiday, Wednesday brings various top-tier economic releases including December retail sales, industrial production and PPI inflation data. Following last week’s CPI report, this week’s PPI release is expected to show that producer energy prices fell for the second successive month, while easing supply-chain backlogs and moderating demand likely further contained pressure on prices of core items, which have averaged increases of 0.3% from June through November after an average of 0.7% in the first five months of the year. Overall, our colleagues at Daiwa America forecast a drop in headline producer prices of 0.2%M/M, and a rise of just 0.2%M/M in core prices.

Meanwhile, the value of retail sales is expected to have been weak, impacted by a decline in new vehicle sales, lower petroleum prices, cautious spending on non-essential items and disruption from severe winter storms in the second half of the month. Overall, our colleagues at Daiwa America forecast a drop in total sales of 0.6%M/M, a touch better than the Bloomberg survey consensus (-0.9%M/M). The IP report is expected to have remained weak, with a drop in manufacturing output last month likely to be partly offset by higher utilities usage amid the cold temperatures. In addition, the back end of the week will bring housing starts and existing home sales data on Thursday and Friday respectively.

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