Previous stimulus measures still need time to play out
By Sean Connery, Portfolio Manager. Posted on Expert Investment Views: Invesco US Blog.
The Bank of Japan (BoJ) announced at its April 28 policy meeting that it would keep monetary policy unchanged. Invesco Fixed Income has been inclined to think that the BoJ would wait. It was only in January that it eased policy last, and we had anticipated that it would want to fully assess the impact of those actions before easing further. Furthermore, the recent increase in oil prices and weakening in the yen may have bought the central bank some additional thinking time. However, recent polls indicated that many non-Japanese investors had expected easing.
This means that:
- The 80 trillion yen target of asset purchases per year was left unchanged.
- The composition of purchases was left unchanged.
- The negative interest rate on cash bank balances (-0.1%) was left unchanged.
There was, however, a minor modification to policy announced. Zero-interest loans and negative interest rate policy (NIRP) exemptions were provided to earthquake-hit banks in Kyushu.
Weaker economic environment
The BoJ's decision not to implement additional easing came despite the fact that:
- The central bank revised down its growth and inflation forecasts for fiscal years 2016 and 2017.
- It was announced earlier in the day that consumer prices had once again moved into negative territory and that household spending had declined.
- The central bank announced a further postponement of the timeframe for reaching its 2% inflation target (to sometime in fiscal year 2017).
- Spring wage negotiations had surprised to the downside.
So why the delay?
We believe there were a number of reasons that the BoJ decided not to act yet:
- The current BoJ has tended not to get involved in incremental adjustments at each meeting. Having eased in January, the bar to ease again in April was quite high.
- Officials wanted more time to assess the impact of negative rates. There is a general perception that NIRP has not been successful, but borrowing costs have declined since the introduction of this policy and bank lending is now at its highest level since 2002. It is clearly having some positive impact.
- The weakening in the yen and increase in Japanese share prices in the run-up to the meeting, accompanied by the recent rise in oil prices, meant that deflation concerns have lessened somewhat.
- The financial markets appeared to expect additional easing. It is questionable whether any easing would have had the desired impact.
- The US Federal Reserve was bullish enough in its April 27 policy statement to suggest that the possibility of a June hike had not been taken off the table.
Market reaction to the news
The market was clearly disappointed with the meeting outcome:
- The yen rallied around 3% after the announcement (against the US dollar) but it has not pushed through the April 11 low of 107.63.1
- Japan's Nikkei Stock Average declined in excess of 3.5%.1
- Japanese government bonds (NYSEARCA:JGBS) rallied, primarily at the longer end of the yield curve.1
Where do we go from here?
- Invesco Fixed Income expects inflation will continue to come in significantly below expectations (primarily impacted by lower oil prices and stronger yen).
- If wages are not going to drive inflation over the near term, Japan will likely need to depend on oil prices to move higher and/or for the yen to weaken to generate inflation.
In terms of currency weakening, we believe Japanese officials can bring that about in one of two ways:
- Unilateral currency intervention. This would not be popular with Group of Seven (G-7) counterparts and is highly unlikely, in our view, given that a G-7 meeting is just around the corner. That said, we expect verbal intervention in the currency market in the days ahead if the yen continues to appreciate. We would expect Japanese officials to act if movements become disorderly.
- Monetary easing. In terms of further BoJ easing, we believe it is likely that any easing would coincide with the release of growth and inflation forecasts at the July or October meetings, but the June meeting or an emergency session between regular meetings cannot be ruled out, in our view. Either of the latter two suggestions would likely take the market by surprise.
Additional options to boost growth
Because NIRP is not popular with savers, we believe this tool is less likely to be used before the July upper house parliamentary elections. We believe it is highly likely that any additional easing would incorporate an increase in non-JGB purchases (in other words, an increased allocation to equities). We believe that supporting the equity market is particularly important for two reasons:
- This is seen as a barometer of success for Abenomics, the Japanese policy framework to boost growth.
- The government encouraged the large Japanese public pension fund (GPIF) to re-allocate its assets away from JGB's (which have subsequently performed strongly) into equities (which have nosedived) and will need to reverse the declines in the latter if citizens are not to lose confidence in the Abenomics project.
We believe it is becoming increasingly likely that the increase in consumption tax that is planned for April 2017 will be deferred, and that the potential for an expansion in fiscal policy (to coincide with any BoJ easing) is high. This would likely be in the form of voucher handouts that must be used by a certain date, for example. A supplementary budget and corporate tax cuts could also be announced to coincide with any such easing.
1 Source: Bloomberg, L.P., April 28, 2016.
The Nikkei Stock Average, also known as the Nikkei 225 Index, is a price-weighted average of 225 top-rated Japanese companies listed in the first section of the Tokyo Stock Exchange.
The Group of Seven (G-7) is an informal bloc of industrialized countries that meets to discuss economic and other issues. The group includes the United States, Canada, France, Germany, Italy, Japan, and the United Kingdom.
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