Bank of Japan Preview

October 6, 2011

The Bank of Japan completes a two-day regular monthly monetary policy meeting Friday. 

These days monetary policy meetings everywhere have become more difficult to predict.  Global headwinds rippling outward from Europe’s debt crisis have created financial market tensions for everybody, including Japan.  The global situation is very fluid, so a relatively upbeat message from the Bank of Japan after the September Policy Board meeting does not guarantee against some kind of easing now.  Analysts are not really expecting such at this time, however.  The Bank of Japan eased quantitatively in March and even more forcefully in August in a move that was coordinated with nearly $60 billion of yen intervention by the government on a single day that month.  But downbeat parliamentary testimony yesterday by Governor Shirakawa at a minimum prepared markets to expected more cautious language about Japan’s economy.

The Bank of Japan’s overnight money target has been zero to 0.1% since March.  Japanese monetary policy has been in this position before, implementing  a zero interest rate policy (ZIRP) for over a year in 1999-00 and again over five years from 2001 to 2006.  In August, the asset purchase plan and a separate lending facility were expanded by JPY 5 billion each.  These planned purchases are an ongoing program that is not supposed to be completed until late 2012.  The BOJ’s very accommodative stance has plenty of unfinished business, so officials do not need to announce new steps every month to keep busy supporting Japan’s economy. 

Not only did the Policy Board not introduce anything fresh last month, but it also released a more upbeat statement that said economic activity is picking up steadily, that supply-side constraints in the wake of the March earthquake had been mostly resolved, that exports and industrial production were continuing to rise, and that moderate economic growth should persist in the second half of fiscal 2011, which ends in March 2012.

Since the Board met in early September, global conditions have worsened, and Japan was not insulated.  Officials are increasingly concerned that yen strength may threaten continuing economic recovery.  Japan’s currency is some 15% stronger against the dollar than six months ago, and it has appreciated some 60% on a trade-weighted basis since the start of the world financial crisis in August 2007.  From July 22 to October 5 this year, the Nikkei share price index sank 17.3%.  The Tankan survey of business conditions and expectations confirmed improvement between June and September but revealed a guarded mood about possible developments in the current quarter.  Japan’s manufacturing and service-sector purchasing manager readings in September were each below the 50 no-change line at 49.3 and 46.4, respectively.  Retail sales and real household spending were lower in August than a year earlier, and the 0.8% on-month rise of industrial output last month was only half as much as forecast.  Export volumes were just 0.9% higher in August than a year before.  Core private machinery orders, a gauge of future investment, dropped 8.2% in July, twice as much as presumed, and capacity usage is 3.0% lower than a year ago.  The Shoko Chukin index of small business sentiment remains under 50 with a pessimistic reading of 47.2 in September. 

Japan succumbed to recession before 2010 had ended and received new impetus last spring from a trio of disasters.  Real GDP fell at annualized rates of 2.4% in 4Q10, 3.7% in 1Q11, and 2.1% in 2Q11.  CPI inflation will be in the red again after revisions due in August, and nominal GDP contracted during the first half of this year. 

Japanese monetary officials protest that their policy has been very loose throughout the four-year world financial crisis.  Their efforts are clearly not good enough.  M2 expanded at around a 2.6% per annum pace since 3Q07, and bank loans stagnated on balance.  From 2Q07 to 2Q11, real and nominal GDP fell by 1.3% per year and 2.8% per year. Maybe officials should consider adopting an inflation target of 3% or higher, or alternatively a target of 4-5% for nominal GDP, to guide quantitative easing and break the back of deflationary price expectations.

Copyright 2011, Larry Greenberg.  No secondary distribution without express permission.

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