The Daily Update - The BoJ and yield curve targeting – another trick up the Bank of Japan’s sleeve?

The Bank of Japan (BoJ) now seem to have tried enough policy tricks to fill even a samurai’s sleeves with today’s introduction of yield curve targeting, ~0% yield cap on 10 year government bonds, broadening the targeted maturities of asset purchases and an ‘inflation-overshooting commitment’ to complement their continued negative interest rate policy (held at -0.1%) and qualitative easing (for now expected to remain close to the current 80 trillion yen annually).

This shift in policy creates a lot more flexibility for the BoJ without actually doing much to immediately push inflation higher. The fact that the BoJ did not announce the much expected policy rate cut further into negative territory didn’t stop markets from initially reacting positively to the news. But this didn’t even last the morning according to the FX markets; despite affirming that a rate cut is still on the cards the yen dropped below pre-announcement levels to 100.70 after a spike to 102.80 lasting just a few hours. The Topix however held its 2.7% gain to 1352 as a potentially steeper yield curve and postponement of further negative short term rates will be a boost particularly for insurers.

The new flexibility really does put the BoJ more at the helm: it seems to have quietly dropped the concrete and unrealistic 2 year timeframe for reaching its 2% inflation target, forward guiding that an inflation overshoot will be tolerated, broad yield curve targeting rather than allocated QE amounts and maturities and the further possibility of increasingly negative key rates. As such, understanding the BoJ’s thinking, and not just today’s major policy shifts, is becoming ever more crucial for forecasting. As such the details of today’s ‘Comprehensive Assessment’ are just as important for evaluating the mindset of Haruhiko Kuroda, Governor of The Bank of Japan, and those inside the BoJ. Just how daring could they be if deflation concerns persist and the yen strengthens further?

One of the fundamental problems in Japan is that too much income flows to the business sector and not enough to the consumer sector. The so called ‘Fourth Arrow’ of Abenomics, forcing up wages, could yet be implemented to counteract this; so too could hikes in corporate tax and the contentious option of switching to ‘helicopter’ monetary stimulus. Although this last option is still a taboo and politically difficult to implement - and even more so to then retract - Japan is one of the few countries to have conducted helicopter money in the past without causing hyperinflation. In the early 1930s Finance Minister Takahashi allowed direct financing of the government deficit to rescue Japan from the Great Depression. (Unfortunately he was later assassinated for trying to unwind this policy and cut the deficit by reducing military spending. Inflation did surge but not entirely a result of Takahashi’s policies and largely a consequence of World War II.)

So the BoJ do still have some tricks up their sleeve and this latest report suggest that they, like the rest of the world, still regard ‘helicopter money’ as unviable . But there is still the possibility they are already preparing to pull out a fourth arrow, at the very least promoting wage increases to be based on future inflation expectations rather than the preceding year’s measure. After all with full-time wages remaining flat for over two decades many feel it is long overdue. The recent increase of minimum wages in July only directly affects around 10% of the workforce but seems to be having a positive effect. But this is still far from the needed panacea for all of Japan’s headwinds. The public deficit is still around 6% of GDP and public debts already around 250% of GDP (The IMF calculates that this would need to become a 6% primary surplus by 2020 to reduce net public debt to 80% of GDP by 2030). As well as rapidly aging, Japan’s population is expected to fall by 30% by 2060. Increasing competition from cheaper and increasingly technical Asian neighbours will drain production and further weaken labour market bargaining power. In light of this some in the markets are describing the recent move as simply ‘rearranging the deckchairs on the Titanic’. We don’t see Japan’s economy sinking yet but there are clearly still a lot of holes to patch up.

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