Bank of Japan Halloween Surprise

October 31, 2014

Most analysts including myself didn’t expect a policy change, and the package of stimulus enhancements announced by the BOJ Board was approved by only a 5-4 majority, albeit one that included Governor Kuroda and his two Deputies.  This was the first modification of quantitative and qualitative easing (QQE)launched some 19 months ago.  The changes look significant.  The monetary base is projected to now grow at an annual pace of 80 trillion yen, up from JPY 60-70.  BOJ purchases of JGBs are to expand 60% faster than before, and the average duration of the central bank’s JGB holdings are targeted to climb as much as 3 years more than the previously targeted 7 years.  J-REIT and ETF holdings, but not commercial paper or corporate bonds, will increase, too. 

The main drawback is the general view that quantitative easing produces diminishing benefits when lengthened or deepened.  That belief has been fostered by the U.S. experience where QE1 is credited with being much more successful than QE2 or QE3.  Even up to this point, the acceleration of bank lending has been limited.

So how will stimulus result.  Long-term interest rates will stay low and may even decline further.  Export competitiveness and imported inflation will be promoted by yen depreciation.  A complementary re-weighting of Japan’s main pension fund toward Japanese and foreign equities and away from fixed asset securities will hopefully promote business sentiment and encourage capital spending.  The rise of inflation had stalled short of the central bank’s goal of 2.0%, creating the risk that expected inflation would begin sliding if the central bank didn’t augment policy stimulus in a meaningful way.  It has, but the 5-4 vote reveals a very polarized Board that could lose faith in the project unless growth and inflation reaccelerate soon.  

The main litmus tests lie in market behavior.  Pay attention to JGB yields, the Nikkei-225 index, and most importantly the yen.  Beyond that, analysts will be waiting to see how inflation and growth do in the first quarter of 2015.  The original hope had been that 2.0% core inflation would be secured by April 2015 in a way that appears likely to endure.  That date of timing has now slid to October 2015, but a lack of progress by the start of fiscal 2015 next April would deal a blow to confidence in Abenomics.

The other aspect of today’s action is how it contrasts with the recent end of Federal Reserve quantitative easing what ECB officials now do.  Led by Germany, intra-ECB squabbling in public has been rising over whether to stimulate European growth in unconventional ways.  It will be harder in the future for the ECB to get by with rhetoric not matched by real action.  The BOJ has put the ECB in a delicate spot. 

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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