Bank of Japan Preview: No Rate Hike on Radar Screen

November 19, 2009

The BOJ released new quarterly forecasts at its previous Policy Board meeting on October 30, which penciled in projected core CPI inflation of minus 1.5% this fiscal year, minus 0.8% in Fiscal 2010, and minus 0.4% in Fiscal 2011 ending March 2012.  Unless that deflationary view somehow changes, a rate hike is not likely before the second half of 2011 at the earliest.  The BOJ’s overnight uncollateralized money rate has been 0.10% since last December, and the three-month euroyen deposit rate of 0.31% is very similar to its U.S. counterpart.  Regarding quantitative easing, the BOJ last month decided to stop outright buying of commercial paper and corporate bonds at the end of this year but extended the end-date on its more widely used special funds-supplying operations to March 2010 from December.

A big difference between Japan and other central banks in this global financial crisis is that the Bank of Japan’s target interest rate fell merely 40 basis points in total since its onset in contrast to drops of 500 bps in the Fed funds target, 325 bps in the ECB refinancing rate and 450 bps in the British Bank Rate.  Japan’s target rate has been no higher than 0.5% since September 1995.

Another distinguishing characteristic of Japan is a projected 200% debt-to GDP ratio next year that will eclipse those in all other developed economies.  With a new, more leftist government now in charge of the fiscal domain, there has been concern that Japanese long-term interest rates will climb substantially in the coming year, boosting debt service expenses.  A similar scare after the Asian crisis, saw the ten-year JGB yield soar from 0.67% on September 17, 1998 to 2.47% on February 5, 1999.  The yield had drifted upward to 1.42% at the time of the end-October meeting and climbed further to 1.48% by November 9th, but it dropped back more recently and touched 1.29% today, lowest level since October 14th after a 20-year auction attracted plentiful investor interest.

Japan’s economy remains much weaker than the 4.8% annualized GDP increase in 3Q09 suggests.  Since 4Q90 when Japan’s prolonged economic problems began, there have been seventeen different quarters out of a total of 75 quarters in which real GDP expanded by 3.5% or more at an annualized rate.  Nonetheless, GDP has advanced only 0.8% per annum over that period of nearly two decades.  Japanese national income accounts suffer from notorious measurement shortcomings, and the data series tends to be extremely volatile.  Growth in the third quarter stemmed from an enormous and unsustainable inventory swing and fiscal incentives that also will not continue to provide major thrust.  The yen, which was stronger than 90 per dollar at the time of the October meeting and also today, will constrain future exports, and department store sales were today reported to have been 10.5% lower in October than a year earlier.  That was the twentieth straight on-year decline.  Notwithstanding declining movements today, most stock markets in the world show a net rise for November so far, but Japan, whose Nikkei is down 1.7%, is not one of them.

The economy is very vulnerable, and fiscal policy is walking on egg shells.  The Bank of Japan has no choice but to retain ZIRP (zero interest rates) for considerably longer.  If nominal money rates were higher, the central bank would in fact be cutting them to alleviate upward pressure on the yen.  The lack of intervention reflects the view that using that tool probably would be ineffective, not any satisfaction that firms will be able to cope with the currency’s rise.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.



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