Bank of Japan Tries to Get Ahead of the Market

October 5, 2010

Stocks rose, long-term interest rates fell, but the yen remained strong and steady following what the BOJ web site entitles a Comprehensive Monetary Easing.  The Policy Board deliberated for six hours and 53 minutes over two days and voted 9-0 to ease policy in several ways.  Here’s what they decided.

  1. To cut the overnight money target to 0-0.1% from 0.1% (observed since December 2008) and to call the new stance “virtually zero interest rates,” harkening back to the so-called ZIRP policy of 2001-06 and, more briefly,  from March 1999 until August 2000.
  2. To announce two criteria for ending this third trip down ZIRP lane: a) the judgement of the Board that medium- and long-term price stability has been reattained (defined to be in the center of a 0 to 2% range) and b) the absence of any significant risk factors to jeopardize such price stability.
  3. To establish an Asset Purchase Program consisting of two parts: a) JPY 30 trillion of funds-supplying operations against pooled collateral, an already existing operation started in December 2009 and expanded in March 2010 and further in August 2010, and b) the purchase of JPY 5 trillion, JPY 3.5 trillion of which consisting of JGB’s and the rest of commercial paper, asset-backed commercial paper, corporate bonds, exchange-traded funds, and real estate investment trusts.

The Bank of Japan in fact could have done more.  Officials did not increase the JPY 30 trillion size of funds-supplying operations any further, nor was the JPY 1.8 trillion of outright JGB purchases per month, the pace since March 2009, raised.  Analysts were anticipating the former, and government officials have been pressing for the latter step.  The asset purchase program will be allowed to expand the central bank’s balance sheet.  JPY 5 trillion is 4% of the the JPY 124.6 trillion size of the balance sheet as of September 20, while JPY 35 trillion represents 28% of it.  Other central banks like the Fed grew their balance sheet much more sharply that that.

The notion of price stability as “falling in a positive range of 2% or lower, with a midpoint “understanding of around 1%” is far too low for an economy that’s been mired in deflation for more than a decade.  Until achieved for an uninterrupted period of somewhat more than a year, officials should aim for a midpoint of 2%.  Only then will all remnants of deflation be purged. 

It’s not surprising that the yen did not fall back today.  Typically, the translated statement from the central bank has areas of ambiguity regarding exactly what will be done and when.  This will be the third experience with zero interest rates.  The first two did not end deflation sustainably, nor did they pave the way back to a decent long-term growth trend.  Moreover, other central banks like the Fed and Bank of England are contemplating new quantitative easing.  An undervalued yen was possible when only Japan had very low short- and long-term interest rates.  The current landscape with many economies having the same circumstances will persist for the foreseeable future.  In this different metric, Japan’s chronic current account surplus keeps the yen well bid.

The economic backdrop to today’s shift by the Bank of Japan has been

  • A stronger yen than officials want even after undertaking heavy intervention.
  • A downwardly revised Japanese growth path compared to that envisaged in the July interim assessment.
  • Slower growth in export markets and weaker business sentiment at home.
  • A possibility that weaker-than-expected economic activity will impede the gradual elimination of core CPI deflation that has anchored the central bank’s baseline forecast for the past year.

Unless the yen drifts back to 85-90 per dollar, which does not seem to be the most likely scenario, more policy efforts will need to be thrown at the problem.  International politics, not economic considerations, has prevented officials from intervening on the scale of what it did September 15 on a more daily basis.  Sustained massive intervention, backed up by changes to domestic monetary policy, could yield better results than last month’s effort to push the yen lower.  In the meantime, BOJ Governor Shirakawa implied today that the size of the asset purchase program could be raised if necessary.

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



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