Bank of Japan’s monetary-easing gambit faces nervous wait
Just months into Japanese prime minister Shinzo Abe’s master plan to end deflation and kick-start the economy, the jury is out on whether he can succeed.
The three-pronged plan, dubbed Abenomics, deploys all the economic tools available to government – monetary policy, fiscal policy and growth policies – in a bid to reverse falling prices and achieve 2% inflation in two years. The most controversial element is monetary easing on an untested scale, which will see the Bank of Japan (BoJ) inject ¥132 trillion ($1.35 trillion) into the economy through open-ended buying of assets, mostly JGBs.
The rationale for the bond purchases is the same as that justifying quantitative easing in Europe and the US – that is it boosts liquidity, driving down the cost of borrowing, and makes lending relatively more attractive than holding government bonds with declining yields.
The BoJ has pledged to hold rates in check long-term by purchasing government bonds of all maturities up to 40 years and to keep going “for as long as it is necessary” to push inflation to 2% and keep it there.
However, as BoJ governor Haruhiko Kuroda has stated, the policy is predicated on raising expectations for faster inflation among market participants, businesses and consumers – and maintaining those expectations.
The prospect of rising prices should spur consumers to start spending to try to beat the increases, and companies to borrow and invest to meet demand.
However, that is not happening.
“Given that financial conditions have been easing since November when Abe promised expansionary policies in his election campaign, the initiative should be gaining traction,” says Guy Foster, head of portfolio strategy at Brewin Dolphin.
“The exchange rate, credit spreads and the equity market are all favourable yet we are continuing to see weak inflation numbers. We would expect to start to see prices ticking up and trade moving.
“It’s also worrying that Japanese investors haven’t shown any great faith. We haven’t seen any great liquidation of overseas bond and equity holdings. If you expect the BoJ to meet its 2% target, why would you want to keep your money outside of Japan?”
Despite gains to be made from the weak yen, ministry of finance figures show net sales of less than 3% of overseas bond and equity holdings in the 16 weeks to April 20.
April’s inflation data showed the fifth straight month of annual declines in Japanese core consumer prices in March, despite the weaker yen.
Leaving aside the diplomatically sensitive issue of whether the resulting yen depreciation is a bid to boost Japan’s competitiveness relative to its neighbours, the stakes remain high.
Standard & Poor’s has warned it could downgrade Japanese government debt from AA- due to the risks the policy poses and the “uncertainty” of its success.
And there are some fairly big risks.
The IMF has forecast that inflation will jump to 3% in 2014 and boosted its estimates for economic growth to 1.6% this year and 1.4% next year. However, the OECD has warned that success is likely to mean higher interest rates that could raise the cost of paying off the country’s debt, which at the end of 2012 stood at 232% of GDP.
Martin Malone, global macro strategist at Mint Partners in London, believes strongly that the strategy will succeed because it comes as the global economy is growing, a period when, historically, Japan has performed well.
“This is the right policy at the right time,” he says. “The government together with the central bank have eliminated any deflation threat in Japan. With this policy they’ve effectively pegged long-term interest rates at 0.5% and JGBs are the transmission mechanism.”
Malone points to the stock market where the Nikkei 225 has surged 34% this year.
“Stocks price in expectations and what we’re seeing is an end to the anti-inflation bond investing of the last 20 years and the re-convergence of Japanese stocks as a leveraged play on the global economy,” Malone says.
Patrik Säfvenblad, investment partner at Harmonic Capital, agrees market perception has turned positive but warns that with the “baggage of negativity”, sharp reversals in sentiment are quite likely and failure – for internal or external reasons – will see markets quickly retreat to their old bearish thinking.
Brewin Dolphin’s Foster says the policy is at a crucial juncture: “It is very important that the jobs and incomes are there to support the recovery. With the yen falling, import costs are going up, especially fuel and food. The big question is can companies pass these higher costs on to consumers, or do they have to absorb them?
“If they can’t pass on price increases they lose their profit margin and end up being driven into bankruptcy, meaning job losses, a worsening economy and lower GDP numbers.”