Tuesday, January 21, 2014

Japan Central Bank in No Rush to Shift Stance

The Bank of Japan (BOJ) is expected to stand pat on policy and keep the 2014-2015 economic forecasts basically unchanged at its monetary policy meeting Tuesday and Wednesday. The BOJ’s GDP forecasts currently stand at 1.5% for both 2014 and 2015. Meanwhile, the central bank projects core consumer price index inflation to rise to 1.3% in 2014 and 1.9% in 2015 (excluding the distortion of consumption tax hike).

By the end of 2013, the BOJ had successfully boosted base money to 202 trillion yen and boosted the holdings of government bonds to 142 trillion yen, in line with the targets set in the "quantitative and  qualitative easing" (QQE) program launched in April 2013. The direct impact of QQE was mainly seen in the FX and stock markets.

The surge in equity prices, combined with the increases in government spending, effectively stimulated domestic demand and helped the economy to recover. The net positive effects of yen depreciation, unfortunately, were smaller than anticipated. Export volumes and manufacturing production have improved only modestly over the past 12 months and the trade deficit has continued to widen.

On the other hand, inflation has jumped due to the rise in import prices and its passthrough effects. Real income growth has deteriorated significantly, eroding the spending power of fixed income earners.

Given the above, policymakers may find it necessary to review the benefits and the costs on the domestic economy as a result of extraordinary policy easing. In addition, the external environment is also changing. Because of the Fed’s announcement of quantitative easing tapering, the US dollar-yen rate has automatically moved to higher levels of 104. Given the divergence in US-Japan monetary policy and the strengthening of market expectations about yen depreciation, the need for the BOJ to take actual actions to ease policy further has decreased.

Overall, we think the BOJ is in no rush to make changes to the current QQE programme. In the next few months, policymakers will likely pay close attention to the results of wage negotiations in March and the impacts of consumption tax hike in April in order to assess the sustainability of economic recovery. Further policy easing, if required, may only come in June or July at the earliest.