The dan­ger of fur­ther BoJ eas­ing

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

There is grow­ing spec­u­la­tion that the Bank of Ja­pan may fol­low the Euro­pean Cen­tral Bank, which last week sig­nalled ad­di­tional eas­ing, and the Peo­ple’s Bank of China, which cut rates on Fri­day, and sur­prise the mar­kets with fur­ther credit eas­ing.

But while ex­tra ac­tion from the BoJ could be a short term shot in the arm for the eq­uity mar­ket (or not, given the un­der­whelm­ing re­sponse to China’s eas­ing), it is doubt­ful whether ad­di­tional eas­ing will fur­ther the cause of Ja­panese re­fla­tion, while any re­sult­ing yen weak­ness could do more harm than good. In its board meet­ing on Fri­day, the BoJ is ex­pected to down­grade the growth and in­fla­tion fore­casts it is­sued in July to re­flect the slow­down in emerg­ing mar­kets and con­tin­ued low oil prices.

With head­line in­fla­tion at just 0.2% in Au­gust, it could be ar­gued that the cen­tral bank should do “what­ever it takes” to hit its 2% in­fla­tion tar­get. How­ever, there are also rea­sons why the BoJ may pre­fer to stick with its cur­rent “quan­ti­ta­tive and qual­i­ta­tive eas­ing” pro­gramme. Most no­tably, head­line and core — ex-food — in­fla­tion have been weighed down by lower fuel prices. On a sea­son­ally-ad­justed six-month an­nu­alised ba­sis ex­clud­ing the one-off ef­fect of last year’s sales tax hike, “core core” in­fla­tion — ex-food and en­ergy — is run­ning at a decade high of 1.4%. So, with the oil price ap­pear­ing to have found a bot­tom, the BoJ can rea­son­ably point to Ja­pan’s tight­en­ing labour mar­ket as a sig­nal of a likely pick-up in in­fla­tion ex­pec­ta­tions.

The BoJ is also run­ning up against the tech­ni­cal lim­its of its QQE pro­gramme. The cen­tral bank is al­ready the largest holder of Ja­panese gov­ern­ment bonds, with a 30% share of all out­stand­ing is­sues. Fac­ing the prospect of di­min­ish­ing re­turns from fur­ther pur­chases, it is keen to con­serve its am­mu­ni­tion to en­sure that any ad­di­tional ac­tion it is forced to take has the great­est pos­si­ble im­pact.

As a re­sult, in the ab­sence of an ex­oge­nous shock, the BoJ is likely to be re­luc­tant to ex­pand QQE ahead of fis­cal con­sol­i­da­tion cur­rently planned for April 2017, when a fur­ther con­sump­tion tax hike should be im­ple­mented.

What’s more, en­thu­si­asm among gov­ern­ment of­fi­cials and busi­ness lead­ers for a fur­ther weak­en­ing of the yen has cooled lately af­ter the last round of de­pre­ci­a­tion failed to boost ex­port growth as much as hoped. The im­pact was muted in part be­cause Ja­panese ex­porters chose to take ad­van­tage of the yen’s weak­ness to re­build their prof­itabil­ity rather than to in­crease ship­ment vol­umes, and partly be­cause Ja­panese man­u­fac­tur­ers are more linked in to the global sup­ply chain than be­fore, with fewer of their costs de­nom­i­nated in yen and more of their pro­duc­tion off­shore.

As a re­sult, the cen­tral bank’s pol­icy of eas­ing-in­duced cur­rency de­pre­ci­a­tion has at­tracted crit­i­cism for ex­ac­er­bat­ing eco­nomic in­equal­ity by boost­ing ex­porters’ prof­its at the ex­pense of do­mes­tic con­sumers, whose pur­chas­ing power has been re­duced, which in turn has hit smaller com­pa­nies’ earn­ings.

Hav­ing said that, Ja­panese ex­porters have changed their be­hav­iour since the be­gin­ning of this year by start­ing to cut their prices. As a re­sult, in con­tract cur­rency terms Ja­pan’s ex­port prices have fallen -6% over the last 12 months (see the chart).

How­ever, rather than boost­ing Ja­pan’s mar­ket share, the price cut trig­gered cur­rency de­pre­ci­a­tion across Asia, with the Korean won and Tai­wanese dol­lar also weak­en­ing.

That shouldn’t have been too sur­pris­ing, given that re­fla­tion poli­cies have gen­er­ally been a zero sum game. Their ef­fect has been to re­dis­tribute nom­i­nal growth among economies rather than to boost over­all ag­gre­gate de­mand. As a re­sult, when one ex­port-ori­ented econ­omy de­val­ues, the cur­ren­cies of oth­ers also come un­der pres­sure, even if that means tighter financial con­di­tions as the cost of ser­vic­ing for­eign cur­rency li­a­bil­i­ties rises.

In con­se­quence, at this point ad­di­tional eas­ing lead­ing to fur­ther yen de­pre­ci­a­tion could end up do­ing more harm than good. Al­though a sta­ble yen im­plies a cycli­cal de­cel­er­a­tion in ex­porters’ earn­ings growth, the eas­ing poli­cies pur­sued to date have helped over­come the en­trenched de­fla­tion­ary mind­set of Ja­panese cor­po­ra­tions, en­cour­ag­ing them to in­vest more and in­crease com­pen­sa­tion.

Mean­while, struc­tural re­forms are gain­ing trac­tion, hold­ing out the prospect of mar­gin ex­pan­sion in do­mes­ti­cally-ori­en­tated sec­tors. If the BoJ were to in­tro­duce more ag­gres­sive eas­ing now, it would risk jeop­ar­dis­ing this frag­ile equi­lib­rium as ad­di­tional yen weak­ness would fur­ther de­press de­mand both at home and among Ja­pan’s trad­ing part­ners—a beg­gar thy neigh­bour ef­fect which would even­tu­ally come back to haunt the Ja­panese econ­omy.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.