Bank of Japan Review

December 18, 2009

Following five hours and 35 minutes of deliberations over two days in its final meeting of 2009, the Bank of Japan Policy Board decided unanimously to leave its target for uncollateralized overnight money at a rate of 0.1% and retained the prior assessments that 1) economic activity is “picking up” and likely to improve at only a moderate pace through next September and 2) that the on-year decline in core CPI will moderate in due time.  All this had been expected by analysts.  Although no concrete new actions were taken, the statement released by the BOJ broke important new rhetorical ground in redefining what pace of inflation will be tolerated and the role of inflation trends in guiding monetary policy.  The backdrop to these changes are 1) the return and intensification of deflation, 2) a marked slowdown in economic growth, 3) newfound doubts in business and consumer confidence,  and 4) political pressure from the new government on monetary officials to promote recovery more convincingly.

The statement attempts to correct a misconception of the central bank’s own making regarding the medium-term acceptable range for inflation.  The previous understanding specified a target of 1% within a range of zero to 2%.  Officials now indicate that zero inflation is not acceptable because anything less, that is any amount of deflation, however small, will not be tolerated.  The impression is given that the new comfort range has a floor of 1% and the same ceiling of 2%.

There’s more…   Emphasis is further made that core CPI inflation, or total CPI for that matter, will not be the be-all and end-all of monetary policymaking.  Officials now regret stipulating the condition of positive core inflation (CPI excluding seasonal food but including energy) as the litmus test for ending the previous experience with a policy of  zero interest rates (ZIRP).  There are no pre-commitments this time, and consumer prices are but one of a multitude of factors that should and will guide policy in the future.  Words are just that — words — and it remains to be seen just how this extra verbal wiggle room is applied in future policymaking.  A schedule of dates for BOJ policy board meetings in 2010 was conveniently posted on the BOJ web site after today’s meeting.

Today’s statement does not introduce any further quantitative easing beyond the limited end-of-year boost to market liquidity with 3-month loans at 0.1%, which was announced after an unscheduled December 1 meeting.  Monthly outright buying of JGBs remains fixed at Y 1.8 trillion, and the prospects of an increase in the 0.1% central bank target rate in 2010 already seemed dim.  What has changed with today’s meeting is a sense of the central bank’s previous low inflation philosophy at all costs and in its dedication to fight deflation as forcefully as it has countered excessive inflation in the past.  I believe that ground zero in this new policy initiative is the yen, specifically doing whatever it takes to weaken the currency while deflation persists.  From a high of 84.83 per dollar on November 27 to a low for the move today of 90.51/USD, the yen has already retreated 6.3%.  This move is at most only half-way completed if officials get there way.  What is needed is for investors to re-embrace the yen as their most favored carry trade, and should that happen, things ought to work out as central bank and government officials hope.  And with the yuan still fixed against the dollar, every percentage point drop of the yen against the dollar is also a percentage point drop against China’s currency.

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

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