Bank of Japan delivers yen weakness but reflation a more difficult trick
The Bank of Japan (BoJ) has delivered on government promises to attempt to reflate the Japanese economy, but while the yen is likely to remain on the defensive, doubts persist over the potential effectiveness of the move in tackling Japan’s deflationary spiral.
The action from the central bank was bold, backing up the pledge from Japanese prime minister Shinzo Abe, who was elected in November after a pledge to reflate the country’s economy and tackle the strength of the yen.
Despite speculation earlier this week that not all the central bank’s policy committee was on board with the ultra-accommodative plans of newly installed BoJ governor Haruhiko Kuroda, he managed to surprise the markets.
The yen put in its weakest performance since October, with USDJPY surging two big figures from below ¥92 to ¥95.50, as the BoJ announced a move from targeting the overnight call rate to targeting Japan’s monetary base, which it plans to double during the next two years.
The BoJ said it planned to undertake “massive JGB purchases”, with holdings rising by ¥50 trillion annually, ahead of analysts’ forecasts, while it planned to increase its holdings of ETFs and real estate trust funds.
Plans to achieve a 2% inflation target in two years also saw an extension in the maturity of JGBs purchased by the central bank out to 40 years, and the rule limiting JGB purchases to below the level of bank notes in circulation scrapped “temporarily”.
Derek Halpenny, head of currency strategy at Bank of Tokyo-Mitsubishi UFJ, says he finds it hard to understand just how that rule could be suspended just temporarily, given that the announced annual JGB purchases of ¥50 trillion are about 16% more than what the Japanese government is projecting as its net issuance for the current financial year.
“With the BoJ now buying out to 40 years, there is a high risk that the financial markets will start to conclude that Japan is moving towards debt monetization,” he says.
“There can only be one conclusion from this policy announcement: the BoJ under governor Kuroda means business and these aggressive steps will prove important in shaping expectations about the direction of the yen and inflation expectations.”
Halpenny believes the behaviour of Japanese institutions such as life insurance companies, in terms of their foreign currency hedging, will be crucial for the future direction of the yen.
“The decision may well convince the Japanese investing community – sceptical until now – of a real shift that will help ensure that, over time, a trend of yen weakness is now established.”
That could see the yen continue on a weakening path that saw it steadily lose more than 20% of its value against the dollar from when Abe made his pledge to tackle the country’s economic problems in October until the beginning of March, since when the Japanese currency’s downward momentum has run out of steam.
Indeed, Hans Redeker, head of global FX strategy at Morgan Stanley, says the aggressive measures announced by the BoJ suggest a resumption of the uptrend in USDJPY and broader support for risk appetite as the yen is firmly established as a funding currency.
He says the move back above the ¥94.50 level in USDJPY is the initial signal that the uptrend is set to be resumed.
“We now expect a move above the ¥96.70 March highs to target the ¥100 level,” he says.
While the yen is likely to come under pressure, some doubt the ability of the measures to stimulate the Japanese economy, given the track record of the country’s policymakers in attempting to fight deflationary pressures in their economy.
Douglas Roberts, economist at Standard Life Investments, says policy initiatives by Japan’s government and central bank to re-energize the economy have been tried and failed for more than 20 years, so it is no surprise there has been a deal of scepticism about the latest policy gambit.
Indeed, he says the present policy might prove insufficient to kick-start the economy.
“The Japanese economy is hampered by an ageing, shrinking workforce, a lack of competition and a severe energy crisis,” says Roberts.
“Without a radical overhaul of these more fundamental aspects of the economy, an initial boost to GDP growth could end up running out of momentum.”
Still, that would appear to be another reason to be bearish on the yen in the longer term.