The Bank of Japan (BoJ) as we expected announced no new easing measures in connection with the monetary policy meeting held today. The target for expansion of the monetary base (currently the main policy instrument) was maintained at JPY80trn annually. The decision was approved in a 8-1 vote. Board member Kuichi was again the dissenter, arguing that the BoJs asset purchases are too aggressive and there should be more flexibility in reaching the 2% inflation target.
In the statement there were only a few small changes to the wording on inflation . The phrase describing the near-term outlook for inflation was changed to "the year-on-year rate of increase in CPI is likely to be about 0 percent for the time being, due to the effect of the decline in energy prices" from "the year-on-year rate of increase in the CPI is likely to slow for the time being" . CPI excluding fresh food and the impact from the consumption tax in January declined to 0.2% y/y from 0.5% y/y. The new wording still leaves room for inflation to decline in the coming months without the BoJ responding with more easing. The bottom line is that the communication from the BoJ continues to be that it can live with a temporary decline in headline inflation as long as the economy continues to recover and inflation expectations do not decline. Inflation expectations have started to tick up again recently (see chart below). We expect inflation to bottom out in the coming months, but there could be renewed downside risk due to the recent decline in crude-oil prices.
In our view, the BoJ is also starting to signal more flexibility in the time frame for reaching the 2% inflation target . So far the message from the BoJ has been the inflation target "should be reached at the earliest possible time within a two year framework." The "two year frame work" has been interpreted as a "deadline" for reaching the inflation target before the end of fiscal year 2015 (ending in March 2016). BoJ governor Kuroda in his recent speeches and todays press conference omitted the two-year frame work in this sentence. Speeches from other BoJ board members have also indicated more flexibility in the time frame for reaching the target. Our current forecast suggest that the 2% inflation target could be within reach in early 2016 , but it depends crucially on oil prices (see chart below).
We do not expect additional easing from the BoJ but on the other hand the current aggressive pace of expansion in its balance sheet is unlikely to be reduced in 2015. In our view, financial markets probably underestimate the risk that the BoJ will start tapering at some stage in 2016.
For the yen, the implication is that fresh easing from the BoJ is unlikely to be a major driver of a weaker JPY for the rest of 2015 . However, interest-rate hikes in the US and domestic institutional investors rebalancing their portfolios out of domestic bonds are both still arguments for a weaker JPY. In addition, it should be remembered that the BoJ's QE programme is already extremely aggressive.
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