BOJ: Institutionalizing Low Inflation

Published on June 14, 2017

It’s not just the Fed and ECB grappling with tepid inflation. After years of record breaking, aggressive, monetary easing by the Bank of Japan, challenges to hitting a 2% inflation target appear embedded most deeply still in Japan, ground zero for global deflationary pressures.

The Monetary Policy Committee of the Bank of Japan will convene on June 15 and 16 for its two-day policy setting meeting following today’s US Federal Reserve Open Market Committee. This meeting, as with so many of the other recent meetings since Governor Haruhiko Kuroda boldly turbocharged the BOJ’s asset purchase programs, will barely raise eyebrows, and there will be no changes announced. But the ground is shifting beneath the BOJ.

*** Behind the formal policy discussions, consideration of when and how to engineer an exit policy from the BOJ’s massive bond purchase program has been picking up, led most aggressively by Japanese private sector economists. That in no small part reflects frustration among BOJ Board Members, under increasing scrutiny now from legislators, that Kuroda’s stated goals of 2% inflation, depreciation of the yen, and a strong economic recovery – aggressive by Japanese potential growth estimates – may in truth be very hard to ever accomplish, and perhaps may not even be appropriate for Japan. ***

*** The question of Governor Kuroda’s succession also hangs in the balance of the exit debates, as his term comes to an end on April 8, 2018. While Kuroda garnered strong grades for the initial aggressive easing policy that lifted Japan out of deflation, the last few years of his term have been marked by a failure to achieve his final targets, with no shortage now of second guessing and disappointment dogging him on the political front. The betting in Tokyo political circles is that Prime Minister Shinzo Abe will nevertheless re-appoint Kuroda – a continuity markets will likely applaud – but if anything, to keep him accountable for his current policies, with economic momentum and targets that not many BOJ officials may be keen at this point to sign on to. ***

And truth be told, for all the reiteration of his aggressive 2% inflation target, Kuroda, after multiple delays in hitting his inflation objectives, has already managed expectations downwards. After all, what is there not to like in an economy with a high standard of living, solid corporate sector and business profits, and a 2.8% unemployment rate

A Live but Still Premature Exit Debate

In September of 2016 the BOJ raised eyebrows when it issued a report concluding monetary policy hadn’t brought about the sustained rise in inflation that had been expected due to a strong belief among corporates and households that deflation will persist in Japan simply because…well…it has in the past.

Whether justified or not – and with the caveat that even at a roughly one percent growth and inflation rate the Japanese economy still has much to show for itself – this report was widely interpreted as a not too subtle effort by the BOJ to abdicate direct responsibility for the continued failure to meet its goals.

And more recently, Kuroda, attending a meeting at his former Asian Development Bank on May 6, noted Japan’s exports had not materially risen since the latest bout of Yen depreciation had taken hold. In addition to deflecting political pressures from abroad, this comment was seen back home also as a de facto acceptance of the existing currency rates, and furthermore a lack of incentive or imperative to push the currency much weaker from here.

This fatalism has grabbed the imagination of the local and business press in Japan, who will be certain to pepper Kuroda with questions after the BOJ meeting on June 16 over an exit strategy. To his and their credit, Kuroda and team will consistently continue to maintain that is a long way off. But that will not stop the debate.

Deterioration of Local Bank Profitability

The question of the cost/benefit of additional easing from here has also been gradually rising to the front.

Even as the BOJ’s aggressive balance sheet expansion fails to generate any additional significant momentum to the economy, its effect and impairment of the Japanese Government Bond market has been growing and severe, and negatively impacting local banks.

With the BOJ owning essentially the entire market by now, the JGB market is for all effective purposes now dead, or more accurately, trading volume is remarkably low.

Local banks feeling they cannot get appropriate returns anymore from JGB markets started shifting to over-weighting US Treasuries last year. But after the rise in US yields following last November’s US Presidential elections, many local banks are suspected to be carrying capital losses on their books and on these US dollar asset holdings.

The watchdog Financial Services Agency (FSA) has deemed the situation serious enough to start leaking out warnings in press reports that they may introduce new regulation soon to restrict investment by the smaller local banks in fixed income securities.

In theory, if the bond carry trade is curtailed local banks will need to seek returns through an increase in good old-fashioned lending. In reality, the BOJ has flooded the markets dramatically with cash already, and corporates in Japan are far from cash poor and facing little if any shortage of money. As has been the case for so many years, the problem continues to be generating demand, not supply.

Another Abe Political Distraction

On the (relatively quiet) political front, the opposition Democratic Party of Japan and media have in the meantime latched on to a new scandal with which to harass Prime Minister Shinzo Abe, on the heels of the “Morimoto School” scandal.

At issue is permitting for a new Veterinary Medicine Department for the Kake School in the Shinkoku area, and whether Abe inappropriately pressured the Ministry of Education to grant the vet school a speedy permit due to personal ties to the institution.

But this scandal is yet another red herring from the hapless DPJ. Officials conceded there is some possibility the Cabinet Office may have stepped in on the permitting process, but they maintain this is exactly what the Cabinet Office is supposed to do – speed up permits and promote deregulation.

Public support for Abe, despite perhaps a certain degree of fatigue after such a long tenure, remains relatively solid.

Looking ahead, the Tokyo Metropolitan Assembly will be holding an election on July 2, where Governor Yuriko Koike, formerly the first female Minister of Defense of Japan, and a potential challenger or successor to Abe down the road, is expected to keep her seat.

But her popularity has eroded a bit after some issues surrounding the delivery of fresh food in the Tokyo region, and those elections are not expected to present a major blow of any kind to Abe’s solid position at the helm.

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