Tomorrow will bring the end of a two-day policy meeting at the Bank of Japan which SocGen expects will result in the announcement of additional easing measures. Whether medium-term macro-economic issues or short-term risk tolerance fading weighs heavier on their minds as their efforts from the previous easing announced on Feb 14 are rapidly losing their effectiveness - especially evident in their recent inability to restrain JPY appreciation (which notably JPM believes will continue on the back of a disconnect between Commitment of Traders positioning and the JPY carry divergence - via Bloomberg's chart-of-the-day). Critically the exchange rate is a cornerstone of BoJ policy and while risk-off will drive JPY appreciation via carry unwinds (in a purely technical world) the political, currency, and economic factors that SocGen lays out suggests strongly that the BoJ (under increasing attack from politicians for its failure to reflate the economy) will bring out yet another bazooka to show its worth - and prove this time is different even as we noted here with inflationary concerns rising. Lastly, will JPY lose its carry-trade attractiveness and implicitly its impact on US equities even if they do ease dramatically or when will the market/politicians lose patience with a drip-drip-drip approach and side with China's view of a rising devaluation risk as we noted here recently.
Societe Generale: Further Easing Likely
We have previously predicted that the BoJ would maintain a wait-and-see stance for the time being. However, we now expect the Monetary Policy Meeting scheduled for April 9-10 to result in additional easing measures. There are three reasons why Japan’s central bank will opt to implement monetary easing measures next week.
1) Political factors:
The BoJ reform proposal revealed by the Liberal Democratic Party (LDP), Japan’s leading opposition party, will push Prime Minister Noda into a difficult position. Under the proposed reform, the BoJ will be required to end deflation with a specific time limit, and the government may dismiss BoJ executives when the central bank fail to meet its objective. This would naturally be unacceptable for the BoJ. But unless the BoJ adopts a clear stance as a deflation fighter, Mr. Noda will find it difficult to oppose the LDP’s reform bill. Many Diet members within the Democratic Party of Japan (DPJ) also appear to support the aims of the reform bill, and Mr. Noda will want to avoid any proliferation of issues that could divide the party. In this sense, both the BoJ and the Noda cabinet would benefit considerably if the central bank decides to implement monetary easing measures at this time and to maintain its deflation fighter stance.
2) Currency factors:
Since 2009, the BoJ has focused on the exchange rate as its channel for influencing the real economy through monetary policies. All of the key shifts in the BoJ’s monetary policy over the past few years, including the introduction of 3-month fixed-rate operations with a price stability goal centering on 1% in December 2009, the establishment of the Asset Purchase Program in October 2010, and more recently the adoption of an inflation goal in February 2012, have been targeted toward the reversal of expectations of a higher yen. The easing of monetary policy in February 2012 triggered a shift in the trend toward a higher yen, but the effects appear to have waned in recent weeks. The BoJ can stave off the emergence of high yen expectations by indicating that it cannot rule out additional easing measures.
3) Economic factors:
In 2012, the Japanese economy is expected to achieve high growth thanks to the stimulatory effect of reconstruction demand. We are predicting 2.4% growth in this calendar year and 2.6% in the fiscal year ending March 2013. However, reconstruction demand will start to fade in 2013 and beyond, and the economy will also come under considerable downward pressure from the consumption tax increase in 2014. Japan needs to ensure that the baton is passed smoothly from reconstruction demand to other sources of demand, especially capital investment and consumer spending. BoJ could help ensure such transition through holding down the expected real interest rate with the combination of keeping its virtually zero nominal interest rate and higher inflation expectation. Since it takes between six months and year for the effects of monetary easing to permeate through to the real economy, it is appropriate to implement easing measures now in anticipation of an economic slowdown in 2013.
Specific easing measures
What measures would be appropriate if the BoJ decides to implement monetary easing measures on April 10?
Raising the inflation goal to 2%?...
As indicated in the minutes for February 14, the BoJ appears to be considering an increase in the inflation goal from 1% to “a positive range of 2% or lower.” Lifting the inflation goal posts to 2% would certainly strengthen the effectiveness of the policy interest rate along the time axis. We believe that the inflation goal should be moved to 2% in the medium/long-term perspective. However, Japan’s CPI remained at the low end of the 1% range even during the bubble era of the early 1990s, while the average for the period since 1980 is just 0.5%. It would be necessary to think carefully about whether a CPI rate of increase in the high end of the 1% range would be appropriate for Japan. Furthermore, trends in the OIS market already suggest that the rate is unlikely to rise for about five years, which means that there would be little benefit in terms of strengthening the time axis.
An increase in the Purchase Program…
An increase in the Purchase Program, especially for government bonds, seems an appropriate way for the BoJ of ease monetary policy at this stage. If purchases are increased by around ¥5 trillion, it would be necessary to expand the scope of purchasing, which is currently limited to bonds up to two years, to include bonds up to five years. However, we do not believe that the BoJ needs to specify this next week. The announcement of an increase in the Purchase Program would be sufficiently effective in its own right. The prices of risk assets, such as stocks, purchases of which have not increased recently, are now higher than previously. It would not be inappropriate to include a certain amount of these assets in the scope of purchasing as a way of emphasizing the BoJ’s stance as an inflation fighter.