The BoJ’s tantrumless taper

When the Bank of Japan’s board meets on Wednesday and Thursday, at least one member will be calling for a retreat from the central bank’s policy of negative interest rates coupled with quantitative easing “with yield curve control”. In a speech last month, Takahide Kiuchi called on the BoJ to taper its purchases of Japanese government bonds from JPY 80 trln annually to JPY 45 trln. The chance that the central bank will announce any such change in QE is negligible; other board members insist it will stick to its course. However, the truth is that behind the scenes the BoJ is already reducing its bond purchases, and policymakers appear relaxed with this stealth tapering.

Judged against its headline aims, the BoJ’s policy stance has clearly been a failure. Growth remains lacklustre. Inflation expectations haven’t budged. Underlying inflation, ex-food and energy, is barely in positive territory. And the BoJ has no realistic chance of achieving its target of 2% inflation plus an overshoot within the foreseeable future.

On the other hand, there are signs that the central bank’s policy is gaining some traction, at least as far as its secondary objectives are concerned:

- New lending to households jumped 20% in 2016. The increase was driven primarily by home-owners taking out cheap mortgages in order to upgrade. But investors also played a significant role, buying second properties in pursuit of rental yields of 4% or more and capital gains.

- This interest has fed through to the broader real estate market. Lending to developers rose 15% in 2016 — double the growth rate of 2015 — to a record of JPY 12.3 trln. As a result, major cities are enjoying their first unambiguous property bull market in decades, and construction activity has picked up strongly.

- With Japanese companies able to raise three-year money for 0.2% or less, corporate borrowing increased by almost JPY 1 trln in 4Q16. Admittedly, outside the property sector little of this is being used to fund investment in new domestic capacity — corporate Japan remains cash rich. However, a sizeable proportion is being used to finance equity buybacks and mergers and acquisitions. M&As, domestic and foreign, reached 3,047 in 2016, worth JPY 21.4 trln. Continued activity should help to support the stock market, boosting domestic sentiment in line with the objectives of Abenomics.

- Low bond yields are forcing institutions to allocate more of their assets to riskier investments such as private equity and the stock market, again in line with government policy. This has paid off handsomely for the Government Pension Investment Fund, which generated returns of 8% in 4Q16 alone. Additional switches will further support stocks.

- With short term interest rates in negative territory and the 10-year JGB yield pinned by the BoJ in a narrow range between -10bp and 10bp, the harsh operating environment is prompting consolidation among small regional and local co- operative banks — objectives.

It can be argued that the BoJ has paid a high price for these limited achievements. On the one hand, the BoJ’s QE policy has drawn fire from officials of the new US administration, who have accused Japan of manipulating the value of the yen. On the other, the combination of negative rates and QE has depressed returns in Japan’s financial sector, leaving it even less able to support reflation.

The first objection seems to have been largely smoothed over during prime minister Shinzo Abe’s visit last month to Mar-a-Lago. And the second has been at least partially dealt with by the BoJ’s decision last summer to allow yields to rise at the very long end of the yen curve, boosting returns at Japan’s big bond-holding institutions.

This decision, in conjunction with the BoJ’s “yield curve control” pinning the 10-year JGB yield at zero, has naturally meant the BoJ has acquired fewer assets in the market. As Kiuchi politely pointed out last month, targeting both the quantity of bond purchases and the price of bonds is contradictory. As a result, the BoJ’s holdings of Japanese government securities grew by JPY 34.1 trln in 2H16, compared with JPY 51.4 trln in 1H. Early indications are that the pace has slowed a touch further this year.

In other words, the BoJ is already tapering in order to reduce the stresses on the financial sector, and has been doing so for some months. However, don’t expect any acknowledgement of that at this week’s meeting. The BoJ

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long-held learned to its cost the dangers of announcing policy changes prematurely back in 2006, when it increased its short term interest rate from zero.

Rather than risk choking off any new nascent upturn, policymakers will insist they are maintaining their “highly accommodative” policy stance unaltered. And with 2%-plus inflation unachievable, they will be grateful for any upside in asset prices and lending they can get.