Japan: BOJ Looking through the Soft Patch

Published on April 2, 2014

The advent of spring in Tokyo traditionally brings with it a season of holidays and celebration to go along with the blooming of the famous cherry blossom trees, but this year it was also accompanied on April 1 by the long-awaited hike in Japan’s consumption tax from 5% to 8%.

Prime Minister Shinzo Abe and Finance Minister Taro Aso, in the run up to the decision on whether to actually pull the trigger on the legislated hike, concluded last fall that the economy was in fact ready to bear the short term shock that would surely accompany the hike.

That decision was in no uncertain terms encouraged by Bank of Japan Governor Haruhiko Kuroda, who ensured that the BOJ will take whatever action is necessary to meet its stated 2% inflation target, including if there were to be any setbacks from the sales tax hike (see SGH 8/13/13, “Japan: Leaning towards Consumption Tax Hike”).

*** Despite some jitters now that the day has arrived over some real signs of weakening economic activity, our understanding is that the Bank of Japan will very likely lean towards staying on hold and in fact look through the softer data. We believe that the BOJ will almost certainly not move to add liquidity at its April meetings or, as recently proposed by some influential advisors to Abe, including Koichi Hamada of Yale University, be likely to seriously consider a further round of monetary stimulus even at its May 20-21 meeting when more post–tax hike data comes in. ***

*** There is some concern that retail sales may have failed to have picked up as expected in the run up to the tax hike, even though there was a pick-up in some big ticket items like autos. Industrial production has also pulled back in anticipation of some potential slowing of demand. But expectations are that consumers may be looking through the sales tax to some extent in anticipation of some post sales tax discounting. In effect, the shallower pick-up in the run up to the tax hike may be accompanied by a shallower, and more manageable, drop-off in its wake. ***

** If borne out, this relatively more sanguine economic backdrop may mean that market expectations for further BOJ stimulus, even after May or into the third quarter, could also be misplaced, barring a more significant shock to the outlook for the Japanese economy. A US second quarter rebound, and signs that the US economy is in firm recovery mode, leading to some potential market firming of US rates, may furthermore help do some of the BOJ’s work for it in supporting Dollar Yen without the need for additional action by the BOJ. ***

Tricky, but on the Right Path

The newly added inflation survey component of the BOJ’s Tankan report just released shows that the public and corporate sector inflation expectations, while still short of Kuroda’s ambitious 2% target, have risen significantly to 1.5%, and even 1.7% over a three year horizon.

But there appears to be growing sentiment within the Board of Governors of the Bank of Japan for treading a bit more cautiously on further fueling inflation until there is more significant evidence and more widespread wage growth than the initial but modest wage hikes recently announced in the banking and public sectors.

For now, any offset to the tax hike-related weakness has been and will be relegated to the realm of fiscal policy. Finance Minister Aso has already announced the front loading of two-thirds of the 15 trillion yen in discretionary (non-social security) spending to April to September, the first half of Fiscal Year 2014. Note that even this, however, entails no additional net spending, and that reflects not just fiscal constraints, but also a relative sense of optimism on the outlook.

Regardless, Kuroda is and has been decisive as BOJ Governor, and we would certainly not rule out his willingness and ability to push through new monetary stimulus if and when needed, even over the potential objection of fellow BOJ Governors.

But beyond the positive arguments for staying on hold based on continued confidence in the economic outlook, there are some voices within the BOJ that have questioned the cost, feasibility, and risk reward, of pushing for the extra few basis points of inflation if the BOJ is able to continue on its so far successful course and maintain inflation at a more realistic level, somewhere north of 1.5% – a tremendous result given the years of deflation, structural headwinds, and demographics of Japan.

That risk of course relates to the greater challenge and stickiness in raising wages as opposed to prices, fueling a degree of potential unwanted erosion in real disposable income if not managed properly.

And that debate over the 2% target in Japan might just open the door one day for an interesting discussion on the appropriate rate of inflation targeting for some other developed country central banks, who by then may be looking at the “new” BOJ as a success story rather than a pariah.

Back to list