The Bank of Japan will conclude its two-day Monetary Policy Meeting tomorrow at which the staff will also present its quarterly Economic Outlook report.
The report is widely expected to slash its forecast for inflation yet again, largely due to continued weak oil prices, and, yet again, the BOJ will need to push out the date it expects the economy to hit its 2% inflation target beyond the current second half of Fiscal Year 2016 target that is now clearly not attainable.
*** Beyond those revisions it is a very close call whether the BOJ will choose to ease tomorrow or not, with most analysts leaning towards policy remaining on hold. While a hold for now is very possible and we do not have strong conviction either way, we nevertheless suspect BOJ Governor Haruhiko Kuroda, citing global pressures, just might push his fellow board members to ease further tomorrow. ***
*** Should that not prove the case, and Governor Kuroda decides to hold his fire at this meeting, we expect he will nevertheless tilt in his post-meeting comment towards an upcoming ease and upgrade the by now tired mantra that the BOJ will “move without hesitation if needed,” as a way to underscore that the bank will be monitoring incoming signals from global economies and financial markets for signs of increasing risk. That communication will open the door more explicitly to the possibility of an ease at it subsequent March or April meetings. ***
The Case for Not Waiting
The BOJ will by then have in its hands the results of the all-important Shun-tou spring wage negotiations between management and labor unions to see how much of its stimulus is being passed through by the corporate sector into disposable wages, as well as the outcome to the Federal Reserve’s mid-March meeting to see if there is an assist on its way from the US recovery and a potential boost to dollar yen to keep it at a minimum above the 110-115 level.
But the wage round negotiations have so far already been disappointing, to say the least, looking to come in at this point at around an average of a 0.5% hike in base pay, and from what we understand that will not satisfy Kuroda. And there is little sign of international risks dissipating, or of a March Fed hike for that matter, leading to what could at this junction in the recovery prove to be yet another blow to Japanese corporate sentiment.
So we believe Kuroda just might take the tactical decision to move now, and have a greater impact on markets, rather than wait.
Should the BOJ decide to expand its QQE (Qualitative and Quantitative Easing) program tomorrow, we expect it will hike the monetary base target above the current 80 trillion yen and push the average maturity of bond purchases further out from the current 7-12 year target.
With the BOJ already purchasing or in possession of an enormous portion of the Japanese Government Bond markets, the BOJ can add local government and corporate bonds to its portfolio and also offer an increase in ETF and REIT purchases should it decide to step up its stimulus program.
We do not, however, expect the BOJ to consider buying foreign bonds, which is uncomfortably close to FX intervention, and a cut in the 0.1% deposit rate to negative rates is not on the table now, nor will it be in the future.
Risks to the Outlook
For all that, BOJ officials continue to stress the fundamentals for Japan are not all that bleak.
Indeed there has been little substantial recent change in the outlook for the Japanese economy, and inflation is clearly being pushed down yet again by continued weakness in oil prices.
And while this latest big drop in crude oil prices will have pushed down CPI further, such a phenomenon was already seen last year, and of course lower energy prices are seen to be a positive factor for the Japanese economy. Furthermore, labor markets are gradually improving, as evidenced in the declining unemployment rate.
But even if the BOJ should choose to look through the drop oil prices again, what has changed substantially is the global environment, including financial markets, equity, and foreign currency markets.
Indeed corporate management is seen to be especially cautious to increase wage levels and CAPEX mainly due to a lack of clarity on the international and market risks, including on foreign demand (read China), and not particularly due to a sluggish inflationary outlook. The BOJ of course has little control over these international variables.
The Debate over QQE
But the BOJ, and Kuroda personally, are rapidly losing credibility on the ability to accomplish their 2% inflation target.
At the first stages when the BOJ started to offer massive QQE, Kuroda and Deputy Governor Kikuo Iwata were especially strong believers in the “expectations theory” transmission channel, that is, that if households and corporation believe inflation is coming, they will rush to spend money and that will in turn stimulate the economy.
It did, but that impetus is starting to clearly fade. Japanese households and corporations are still mired deep in doubt, and Iwata for one looks to have given up.
Indeed voices within the BOJ at this point are not uniform on the merits or need for further QQE at all, and many members clearly say in private that due to declining energy prices, accomplishing the 2% target in the near term is neither possible nor even needed.
And along those lines there is an increase focus in new, stripped out, core CPI measures that paint a less dire picture than the headline number (see SGH 7/23/15, “Japan: Changing the CPI Baskets”), or, as Kuroda likes to say, the “underlying trend” in inflation, that is still intact.
Even so, the BOJ does not appear ready to abandon its 2% target, and will lose a good deal of credibility if it does so, and so should it find the need to ease further it is all the more imperative that its actions prove effective. And we expect that in the end to push Kuroda to tilt the BOJ towards another ease, an ease which could well come as soon as tomorrow.