BOJ Guns for Limited Stimulus Expansion

Kuroda increases buying of ETFs by 2.7 trillion yen a year to contain volatility

J1The Bank of Japan (BOJ), reacting to government reports that showed weak economic activity in Q2 FY16, kept its key monetary tools unchanged, while launching a comprehensive review of its policy framework due to uncertainty about the country’s inflation outlook, according to Bloomberg on July 29th, 2016. The central bank will also evaluate the effectiveness of its policies carried out since Governor Haruhiko Kuroda took over in 2013, at its next meeting on September 20-21st, 2016. Kuroda increased the buying of exchange traded funds (ETFs) by 2.7 trillion yen ($26 billion) a year aimed at containing the post-Brexit volatility in financial markets.

BOJ retained its annual target to expand the monetary base at 80 trillion yen, which is done mainly through an equivalent purchase of government bond holdings. It also did not change the minus 0.1% rate for a portion of commercial banks’ reserves. The central bank also expanded the dollar-lending program to $24 billion to support Japanese companies and financial institutions.

The weak economic activity in Q2 FY16 came after core consumer prices dropped for a fourth consecutive month, while consumer spending slumped. Industrial production was the only bright spot in the otherwise gloomy scenario, which included a rising pressure in the country’s labor market owing to the shrinking population. The BOJ and the Government of Japan are jointly looking at achieving a 2% inflation target in the 12 months through March 2018. However, given the current scenario, BOJ stated that further easing will be done if needed in the future.

Source: Cabinet Office, Japan
Source: Cabinet Office, Japan

 

Concerns over BOJ’s massive easing

The government’s decisions to keep the policy interest rate unchanged and not raise the target for the monetary base has increased concerns among investors about the impact of the BOJ’s massive easing. With its easing to date, the BOJ now holds more than one third of Japanese government bonds outstanding. This in turn has resulted in a collapse in yields, with Japanese Government Bonds (JGB) maturities out to 15 years recently staying below 0%. The monetary easing has also flattened the yield curve, and eroded the spread for banks between their short-term funding costs and long-term lending rates.

Source: Bloomberg
Source: Bloomberg

With little to show by supporting the government’s plans since taking the helm in 2013, Kuroda has overseen a massive asset-buyout plan that now stands at a record 80 trillion yen annually.

Source: BOJ, Bloomberg
Source: BOJ, Bloomberg

Abe unveils 28 trillion yen stimulus package

On July 26th, 2016, Japanese Prime Minister Shinzo Abe announced an economic stimulus package worth more than 28 trillion yen ($266 billion) to boost expectations for growth and inflation, just before the BOJ was expected to unveil its own growth-boosting measures. The package would include about 13 trillion yen in fiscal measures, including government spending.

Abe promised a stimulus package, which was earlier reported to be worth 10-30 trillion yen, after the Brexit turmoil sparked a rally in the yen, revealing hidden dangers. This is because traders tend to buy Japan’s currency as a safe bet in times of turmoil or uncertainty. However, the rally in the yen makes Japanese exports less competitive overseas and threatens the profits of Japanese manufacturers.

On June 1st, 2016, Abe delayed an increase in sales tax by two and a half years to boost growth in a country grappling with a near-crisis scenario. The prime minister, whose mantra has been to spur economic growth and promote structural reforms, is also expected to order an extra budget to fund stimulus measures, to avoid what he called an economic crisis on the scale of the global financial crisis that followed the 2008 Lehman Brothers bankruptcy.

Will Japan be able to avert crisis

Japan, the world’s third-largest economy, grew by an annualized rate of 1.7% in the January-March 2016 period, higher than a median forecast of a 0.2% growth. The Q1 FY16 growth marks a rebound from a 1.7% contraction in Q4 FY15. Despite the slight rebound, the economy has not done so well in Q2 FY16, showing that Japan has not been effectively able to break the vicious cycle of falling prices and stagnating incomes. This situation may pull Japan into deflation, which has afflicted the country on and off since the late 1990s. Robust increases in borrowing and spending, and a sustained rise in prices, have been elusive because the strengthening yen, combined with higher oil prices, has raised costs for businesses. These two factors have also cut into profits for exporters, making them unwilling to raise wages. All these factors, combined with the dwindling workforce, have made deflation harder to beat. To add to these woes, consumers have curtailed spending and are maintaining a wary future outlook.

The focus is now on Abe’s fiscal package, which is slated to be reviewed by the cabinet on Tuesday August 2nd, 2016, and is likely to be passed in parliament in October 2016.

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