Bank of Japan Preview

October 4, 2010

Markets are rife with speculation that the BOJ Policy Board will announce some kind of quantitative easing after meeting Monday and Tuesday of this week.  Often, gestures from Japanese officials turn out to be insignificant and made to ameliorate political pressure for easier monetary policy.  This history makes it difficult to impress the market even when something truly significant is decided.  Officials have numerous options.

The last time the BOJ overnight money rate target was reduced was a 20-basis point cut in December 2008 to 0.1%.  Total cuts during the 2008-9 recession amounted to a mere 40 basis points compared to hundreds of basis points’ worth of easing by other central banks.  Officials believe that keeping the rate at zero for a while in 1999-00 and from 2001 until early 2006 damaged money market functionality. 0.1% has been as low as they are willing to go, but that translates into a comparatively high inflation-adjusted rate because Japan has deflation, that is falling prices.  De facto tightening then occurs, because this situation puts upward pressure on the yen.

Officials have also resisted raising their outright monthly buying of government bonds.  The last increase was done in March 2009, a boost to JPY 1.8 trillion per month from JPY 1.4 trillion previously.

Monetary officials also thus far have not gone back to targeting excess reserves as they did in 2001-6, at least not in a formal way.  However, current account balances held by banks at the BOJ, which embody required and excess reserves, have indeed increased, as well they should if the BOJ makes good on its promise not to sterilize foreign exchange intervention.  On September 15, the BOJ as agent for the Ministry of Finance sold over $20 billion equivalent of yen and said that the liquidity thus produced would not be reabsorbed through other operations.  An option open to officials could be to set a target for current account balances and pledge to achieve such by the use of unsterilized intervention.  Current account balances averaged about JPY 28 trillion during the four years to March 2006.  Their average in 2007 after the BOJ stopped quantitative easing was JPY 8.6 trillion, and such fell further to JPY 8.1 trillion in 2008.  But a bigger size of excess reserves was reflected in average current account balances of JPY 12.9 trillion in 2009, JPY 15.9 trillion in the first half of 2010, JPY 16.8 trillion from July 1 – September 15, and JPY 18.2 trillion since the huge intervention in mid-September.  Why not explicitly announce what has already been happening and tie the increase into the resumed policy of yen intervention?

Intervention has kept the yen from piercing its 1995 peak of 79.85 per dollar, but it has not pushed the currency back to 90 per dollar as officials would like.  So they might not wish to focus on a policy that has only partially succeeded and which has drawn criticism from foreign officials.

Another option open to BOJ officials, and the one most widely anticipated, would be a further increase of its funds-supplying credit facility, which was introduced in December 2009 at JPY 10 trillion, doubled in March 2010 to JPY 20 trillion, and raised by 50% to JPY 30 trillion at the end of August.  If that is what gets done, the incremental rise would need to be greater, percentage-wise, than the move in August to impress market players and analysts.  Officials linked the 50% rise in August to efforts to a strong yen and weak equity prices.  Clearly more stimulus should have been provided then.

Yet another policy change to consider would be adopting a more formal inflation target.  Officials have long indicated an “understanding” that price stability lies between zero and 2.0%.  After more than a decade of deflation and very low money and credit growth, officials could do a lot worse than simply co-opting language patterned on the ECB’s “below but close to 2.0%” mantra, but BOJ officials would then need to demonstrate a willingness to keep reflating until money growth and inflation are consistent with that objective.

From a fundamental economic standpoint, the main change since the Policy Board last met is a downgraded assessment by the government officials of industrial production to “flat and likely to be weak.”  New forecasts by the government and hard data for July and August imply a 1.2% drop of output (5% annualized) in the third quarter and a further decline of production in October to about 3% lower than the second-quarter average level.  Japan’s manufacturing PMI reading of 49.5 in September was below the 50 breakeven line for the first time since mid-2009.  Wage earnings in August were unchanged from a year earlier, and on-year growth in the volume of exports slowed to 14.4% in August from 31.9% three months earlier and 45.9% six months earlier.  Real GDP rose just 1.5% at an annualized rate in the second quarter, with personal consumption flat and residential investment dropping 5.1%.  Nominal GDP fell 2.5% annualized in the quarter.  Total and non-food and non-energy consumer prices were each 0.9% lower than a year earlier in August, and the CPI’s annualized rate of drop over the past three reported months accelerated to 2.4%.

The BOJ’s policy announcement will likely be made somewhat after the Reserve Bank of Australia’s.  After the Policy Board met for some six hours over two days on September 6-7, it reported its decision at 5:40 GMT.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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