Bank of Japan Preview

August 8, 2012

The most intriguing aspect of this month’s meeting of the Bank of Japan’s Policy Board is a new composition of membership.  With the additions of Takahide Kuichi and Takehiro Sato, the nine-person committee will be fully staffed for the first time since April.  The new policymakers are trained economists, who worked previously in that capacity at large financial institutions, and they replace Board members with backgrounds as businessmen rather than economists.  More importantly, Kuichi and Sato had previously been critics of the Bank of Japan’s restrained approach to fighting deflation.  The question remains how much these additions might influence monetary policy and how soon a more pro-active approach might appear.  With five-year terms ahead of them, one can hope that a shift toward pro-growth policies may arise, but it’s doubtful that the newcomers will affect decisions right away.  Indeed, that seldom happens at any central bank. 

Most analysts, including myself, expect the meeting today and Thursday to result in no changes either to the 0-0.1% overnight money rate target range or the size of quantitative easing.  A 7-0 vote was cast in July to retain the target range, which has been in effect since October 2010.  The JPY 70 trillion ceiling for asset buying was also unanimously kept, but officials tweaked the composition of such, lifting the asset-purchase fund by JPY 5 trillion and cutting the credit-loan facility by an equal amount.  Twice earlier this year — in February by JPY 10 trillion and April by JPY 5 trillion — quantitative easing was expanded, but four months have passed subsequently without additional follow-through. 

The Bank of Japan has a long-established reputation for overly orienting its policy toward low inflation rather than price stability.  Even the ECB defines price stability as below but close to a 2.0% rise of consumer prices.  For years, BOJ officials declined to quantify a target either for consumer prices or money growth, but their revealed preference was that lower inflation is better in all circumstances.  The road to deflation was paved in the 1990s with excessive gradualism in cutting interest rates, tolerance of chronically minuscule growth in money and bank lending, and an aborted abandonment of quantitative stimulus when the economy was still experiencing deflation.  Over the past dozen years, officials including the Bank governors have repeatedly warned about the dangers to money market functionality of maintaining zero interest rates for too long.  When the Board recently adopted an explicit inflation target, the selection of 1.0% as synonymous with price stability was still below any other central bank’s definition.  Moreover, policymakers continue to talk about deflation in more serious terms than what they are willing to do about such. 

Deflationary prospects have not improved, yet policy has not been relaxed further since April.  Japan’s seasonally adjusted consumer price index recorded month-to-month seasonally adjusted declines of 0.4% in both May and June.  M2 money and broad liquidity posted on-year growth of just 2.3% and 0.2% in the second quarter.  Bank lending continues to show a 12-month increase of less than 1%.  Plus, there are ominous portents of future growth.

  1. The all-industry index has fallen in four of the past five reported months and was 0.3% lower in April-May than its 1Q average.
  2. Government officials re-designated the trend of the index of coincident indicators as “weakening” from “improving” after June’s 2-point plunge.
  3. The manufacturing PMI and services PMI fell in July by 2.0 points and 1.8 points to 47.9 and 47.5.
  4. Core domestic machinery orders, which tend to herald future investment spending, plunged 14.8% in May.
  5. Japanese trade has swung into deficit.  Customs exports and imports fell between May and June by 0.6% and 5.5%, and exports in the first 20 days of July were 2.4% lower than a year earlier.
  6. The economy watchers forward-looking outlook component printed weaker in July at just 44.9.  Such tends to capture shifts in consumption.

The yen’s strength is a mounting concern in Japan that Bank of Japan policy has thus far largely disregarded.  At 78.46 per dollar compared to 119.69 at the start of the global financial crisis five years ago, the yen has advanced 52.5% or 8.8% per annum against the U.S. currency.  At 96.88 per euro versus 165.14/euro on August 8, 2007, it has appreciated 70.5% cumulatively or 11.3% per year relative to the common European currency.  It’s no wonder that exporters are feeling pinched.  The effect of the yen’s appreciation on monetary conditions has not been offset by ample shifts in Japanese domestic monetary policy during the past five years.  The overnight interest rate target was only 0.50% at the start of the period.  A strong yen also promotes deflation directly.

The case for greater Japanese monetary stimulus can also be gleaned from the drop in JGB yields.  The 10-year yield was at 1.76% five years ago, averaged 1.49% in 2008, 1.36% in 2009, 1.18% in 2010, 1.12% last year, and 0.91% so far in 2012.  It is presently at 0.80%.  Investors are not counting on the BOJ Board ever really getting ahead of the curve and defeating deflation once and for all.  Officials are too worried about technicalities like the ballooning fiscal deficit, which was already at 162% of GDP in 2007 and is likely to hit 221% of GDP this year.  The problem is that a worsening debt burden is derived from weak economic growth, so policy restraint is self-defeating.  After all, over the past five years, real GDP has fallen 0.2% per annum on balance, and the personal consumption deflator has dropped 1.0% per year.  M2 money has only climbed 2.4% per year.

One can hope that Sato and Kuichi will make a difference, but don’t hold your breath.  Institutional culture at a central bank can be enormously tough to turn.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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