BOJ: A Bold U-Turn

Published on January 29, 2016

The Bank of Japan stunned financial markets last night in announcing it will cut its Interest on Excess Reserve (IOER) deposit rate from 0.1% into negative territory. That announcement sent dollar/yen, and, after some of the initial shock and market option strike hedges wore off, battered Japanese stock markets soaring.


There was nevertheless a small minority of economists leaning toward an ease at this meeting – a Bloomberg survey had just 4 of 26 economists leaning toward action last night – and SGH fortuitously was in the camp looking for an ease last night as well (see yesterday’s SGH 1/28/16, “BOJ: Tilting Towards an Ease”).


What we were not expecting was the means used to deliver that stimulus, all the more so after repeated pushback from BOJ officials including Governor Haruhiko Kuroda himself as recently as last week in front of parliament as to the desirability or even viability of a negative rate regime for Japan’s banking system and structure.


Kuroda’s move and especially the decision to cut rates rather than add to its bond purchases will thus surely trigger a round of second guessing and skepticism that will likely be exacerbated by the thin 5-4 Committee vote majority with which Kuroda passed the easing measure. But we believe it was an unmitigated shrewd, bold and most of all, necessary U-turn and move.


Building, and Saving, Ammunition


Indeed, as we wrote in yesterday’s report, Kuroda last night pointed to international concerns and the risks to corporate and consumer confidence as reasons for easing now, rather than any major concerns with the domestic economy.


But truth be told the domestic Japanese economic indicators have started to lag as well, leaving, in addition to the embarrassment of having yet again to push out expectations of hitting the 2% self-imposed inflation target by a year now to 2017 and massive downward revision to this year’s CPI forecast, no question as to the desirability if not need for another nice dollop of stimulus.


And an increase in purchasing assets (JGBs, ETFs, corporate bonds, or whatever) would have soon faced severe limitations in many senses, with the general consensus that the BOJ would, unless it dramatically broadened the scope of its purchases, run out of room in a couple of years or so for assets to buy.


Kuroda has now effectively saved the ammunition of an extra say 10-20 trillion yen per year of bond purchases for the future if needed, and added another option on the rate side to his war chest.


And by introducing a three tier structure on deposit rates, exempting the estimated 260 trillion yen of existing bank deposits from negative rates, the BOJ has gone a long way to mitigating the potential negative side effects of the move on the banking system, even if the structure is complicated and undoubtedly will lessen the efficacy somewhat of the rate cut.


That structure will now serve to avoid simply shifting money from bank reserve accounts (current accounts at the BOJ) to their cash accounts: the BOJ has now pre-empted that loophole.


On the Currency and Dissents


As to the currency, the Abe administration had previously protested and verbally tapped markets on excessive yen weakness last time dollar yen spiked above the 125 range.


That was done with an eye clearly on the ruling Liberal Democratic Party’s (LDP) traditional constituency of small business owners and a middle class that would, in contrast to the big exporters, be hurt by too weak a yen. But that was then, this is now.


With dollar yen having spiked already to 121, we suspect this time around there will be no such verbal intervention line at 125, although we would guess a break much above that towards 130 could foster the same dynamics.


So in effect we expect the 115-125 informal dollar yen comfort zone to have now shifted about 5 yen up, to the 120 – 130 area.


As to the internal appetite within the BOJ for further action if needed given the four dissents, two of the four BOJ dissenters, Governors Koji Ishida and Sayuri Shirai, are slated to be replaced by June anyway, presumably with candidates who more closely share Kuroda and the Abe administration’s views.


And as evidenced by the last aggressive action Kuroda took on October 31, 2014, where Kuroda pushed through an ease over an even more contentious, also narrow, 5-4 vote, (see SGH 10/31/14, “Japan: QQE, Yen, and the Looming Sales Tax Hike Decision”), a little resistance will never get in the way of Kuroda anyway were he to feel the economy needed another round of stimulus down the line, either deeper into negative territory or with a step up in the QQE asset purchase program.


In the short run, the market impact of the BOJ’s decision may look small. But in the long run, this can be a big turn-around for Japanese and global markets and investor confidence, with all eyes now turning back again to OPEC, the Fed, and the ECB.

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