Bank of Japan (BoJ) as expected did not raise the limit for its asset purchases in connection with today’s monetary meeting. While BoJ sees increasing signs of the economy shifting to a pick-up phase, it also sees increasing downside risk from the European debt crisis.
Armed with its new inflation target BoJ stays on an easing path and we expect the bank to raise the ceiling for its asset purchases further in the coming months. We also expect BoJ to extend the maturities of its bond purchases at some stage and to continue its asset purchases in 2013, when other major central banks are expected to be on hold.
Details
BoJ as expected did not announce any additional easing measures today. The limit for its asset purchase programme was left unchanged at JPY40trn and the limit for the funds supplying operation credit facility (comparable to ECB’s LTRO) was also left unchanged (at JPY30trn). Finally, the target for the O/N money market rate was left unchanged at 0.1%. All decisions were unanimous.
BoJ’s view of the Japanese economy is largely unchanged compared to the previous meeting. According to BoJ it is “increasingly evident that Japan’s economy is shifting towards a pick-up phase.” It is easy to be cynical about the Japanese economy but it has performed relatively well in recent quarters. GDP expanded 4.1% q/q AR in Q1 12 and domestic demand has expanded by more than 3% q/q AR supported by reconstruction and the reintroduction of subsidies for auto purchases. In recent quarters domestic demand in the world’s third largest economy has actually been expanding faster than in the US, see bottom chart. This underscores that the shift in inflation target and more aggressive monetary easing in 2012 has been driven more by political pressure than changes in macroeconomic fundamentals.
However, BoJ sees increasing downside risk from the international developments, particularly the European debt crisis. While the statement does not explicitly state concerns about a strong JPY, it does mention “that close attention should be paid to the developments in the financial markets.”
Assessment & Outlook
Today’s statement does not change our view that BoJ - armed with its new 1% inflation target – will stay on an easing path. We expect the bank to increase the limit for its asset purchase programme by JPY15trn in several stages during 2012 - mainly to create additional space for continuing its asset purchases in 2013. The next increase will probably be in July, but could happen as soon as the next meeting in June if stress in the financial markets continues to increase. BoJ is also likely to increase the maturities of its bond purchases at some stage (currently only maturities less than three years are eligible). Any substantial appreciation of JPY is poised to be met by more aggressive monetary easing from BoJ and possibly even renewed intervention in the FX market.
BoJ is expected to continue its asset purchases next year, when most other central banks are expected to be on hold and for that reason monetary policy should favour a weaker JPY. That said, increased risk aversion on the back of an intensifying European debt crisis and the possibility of another round of global QE might weigh on JPY in the short run.
USD/JPY has declined by about 0.4% to 79.6 on the back of BoJ’s announcement. There has been no substantial impact on the Japanese bond market from Fitch’s downgrade of Japan yesterday from AA- to A+ (10-year government bond yields up 1bp).
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