Bank of Japan Unlikely to Modify Policy Now

June 13, 2011

A two-day Policy Board meeting on Monday-Tuesday is not expected to modify the Bank of Japan’s target overnight money target range of around zero to 0.1% or the JPY 40 asset purchase ceiling.  At the May meeting on May 19-20, there was a unanimous decision to leave policy steady, and policymaker Nishimura dropped a previous minority recommendation to expand quantitative easing further. 

Japan is in recession.  Real GDP contracted in both the last quarter of 2010 and the first quarter of 2011.  Impetus for the latter came from the Sendai earthquake.  Over the two quarters between 3Q10 and 1Q11, annualized declines were posted of 3.2% in real GDP, 3.1% in consumer spending, 2.4% in non-residential investment, 0.3% in exports and 0.1% in public-sector spending.  The GDP price deflator fell by 1.9% in the year to 1Q11 following a 2.8% decline over the previous four quarters. 

The Bank of Japan’s target interest rate has not exceeded 0.5% since early September 1995.  Such was cut by 20 basis points in October 2008 and another 20 bps in December 2008 to 0.1%.  The target was changed from a point estimate to a range of around zero to 0.1% in October 2010, and asset purchases were raised by five trillion yen at that time.  Three days after the March 11 earthquake, asset purchases were raised additionally by JPY 5 trillion.

GDP could be negative again in the present quarter, but the momentum of the recession has lost some steam.  The manufacturing purchasing managers survey improved to 51.3 in May from 45.7, and the services index recovered to 43.8 — still implying contraction — from 35.0.  Seasonally adjusted retail sales posted a 4.1% monthly rise in April after plunging 7.8% in March.  Industrial production advanced 1.0% in April.  Consumer confidence edged back to 34.8 in May from 28.3 in April and a reading of 27.7 in March.  But unemployment ticked up to 4.7% from 4.6% in March.

Monetary authorities see the economy having to cope with severe supply-side headwinds in the near term but expect a moderate recovery to begin in early autumn.  Government officials concur. 

The recession has adverse implications for a depressed Japanese fiscal situation.  The Fitch credit rating agency recently switched Japan’s outlook to negative from stable, and Moody’s is presently reviewing its assessment of Japan for a possible downgrade.

The looser Bank of Japan policy is reflected in the level of bank reserves held with the central bank, which are now way above their required level.  Current account balances at the BOJ averaged JPY 16.80 trillion in calendar 2010, JPY 18.70 this year through March 11, and JPY 35.44 trillion per day during March 14 – May 19.  The JPY 28.44 trillion average since the last Board Meeting has been high but not as extreme as it was during the immediate aftermath of the earthquake.  The central bank’s balance sheet, which increased from JPY 130.1 trillion at end-February to JPY 142.9 trillion at end-March, settled back to JPY 135.1 trillion by end-May.  Core CPI inflation of +0.6% in April was positive for the first time since February 2009. 

For each hopeful sign, however, there seems to arrive a sobering data point, like today’s news that core private machinery orders fell 3.3% in April rather than rising 2.0% as analysts were predicting.  The April current account of JPY 406 billion was but a shadow of its JPY 1.33 trillion in April 2010, and exports were down 12.7% on year. It would be premature to tighten policy.  Aside from low interest rates and quantitative easing, investors know that officials will intervene if necessary to prevent dollar/yen from sinking significantly below 80.  Japanese currency reserves shot up $19.5 billion in April and rose another $4.0 billion in May.  Since May 19, the Nikkei-225 share price index has lost 1.8%, and the ten-year JGB yield has slid two basis points on balance to 1.14%.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.



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