We no longer expect Bank of Japan (BoJ) to ease further in 2014. First , there just haven't been enough movement in BoJ's communication in a more dovish direction in the past month Second , the recent sharp depreciation has also taken considerable pressure off BoJ for more easing. Third , it now appears that fiscal policy will be tightened less than expected. Fourth , There is increasing focus on the costs from BoJ's aggressive bond purchases with particularly attention on BoJ possible destroying the liquidity in the government bond market.
In our view it will be extremely difficult but not impossible to reach the inflation target next year. Further easing is possible in Q2 next year. We see three options for additional 1) Target for monetary base can be increased by 10-15 trillion yen to 70-85 trillion yen mainly through expansion of bond purchases 2) a more modest increase less than 5 trillion yen by increasing purchases of ETFs and REITS 3) a 10 bps cut in the interest rate on excess reserves to 0%.
Our call of weaker JPY is not dependent on additional easing from BoJ 1) any additional easing will only be marginal additional easing of monetary policy compared to the aggressive monetary easing BoJ is already doing. 2) Public pension funds in Japan are expected to shift their portfolios towards a larger share of foreign securities 3) Fed will gradually start to normalize monetary policy.
On a worrying note the Japanese government now appears to be starting deviate significantly on its target to balance the public primary budget balance by 2020. This will probably not be a major negative for Japanese government bonds as long BoJ continues its QE program. However the reforms that the government is currently implementing will also make the Japanese government bond market much more vulnerable in the future.
To Read the Entire Report Please Click on the pdf File Below