The time wasn’t right for the Bank of Japan. All eyes on October.

September 25 2019

Mansoor Mohi-uddinMacro Strategist, NatWest Markets

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Bank of Japan snapshot: The need-to-know

  • Short-term deposit rate remained unchanged at -0.10%
  • Pledged to keep targeting 10-year government bond yields around zero percent
  • Holdings of government bonds to keep rising symbolically by ¥80 trillion a year
  • Continued to signal interest rates will stay very low at least until spring 2020
  • Will fully review economic outlook at next meeting on 31 October
  • Muted response due to unavailability of key market data

How did markets react?

The market reaction to the outcome of the Bank of Japan’s (BoJ) meeting last week was relatively muted as much of the BoJ’s decisions were in line with the market consensus. Stocks across Asia and Australia rose across the board while the Shanghai composite was flat and the Hang Seng fell. The yen rallied marginally but the dollar remained around 108.

Decisions unpacked: Why did the BoJ choose to do very little?

In the simplest terms, the BoJ chose to make minimal changes to its monetary policy because the time wasn’t right. In fact, there are a number of upcoming data sets and changes over the course of the next month that were worth waiting for before making any core changes. Broadly though, economic growth in Japan is still being supported by low unemployment, firm investment, loose monetary policy and a moderately weak currency, despite escalating trade wars abroad.   

Core inflation – Tankan survey due on 1 October

A key question for BoJ policy makers last week would have been: ‘does the economy have sufficient momentum to eventually push core inflation back to target?’ In assessing this, it was likely that they focussed on two key measures:

1)     The strength of capital expenditures

2)     The evolution of inflation expectations.

Currently, levels of core inflation are subdued at around 0.5% year-on-year, and the aim is to get it back towards the BoJ’s 2% target. Key data on both will be published in the Tankan survey on 1 October for the third quarter of 2019. Because of this, we believe that officials were less willing to take stronger easing action, in the anticipation of this upcoming data.  

Sales tax – set to rise on 1 October

A key assessment for the Bank of Japan would also have been the impact of the sales tax, which is set to rise on 1 October.

The last consumption tax increase in 2014 saw an increase from 5% to 8%, but this jump up hurt growth and inflation expectations. This time around however, the Ministry of Finance has been cushioning the contractionary impact of next month’s sales tax rise through significant fiscal offsets and rebates.  

If Japan’s economy is adversely affected by October’s sales tax rise then the government may prepare a supplementary budget before the end of the fiscal year to support growth. The BoJ is now waiting to see if fiscal policy is loosened – and if the Japanese government bond supply is increased – before choosing to expand monetary policy through stronger bond purchases.  

No fresh economic forecasts – due on 31 October

Another set of data that wasn’t available for September’s meeting was up-to-date economic forecasts.  

Monetary policymakers are due to update their economic projections in the next Outlook Report, which is due on the 31 October, in time for the next BoJ meeting. Stronger easing measures from the BoJ are, therefore, more likely to take place once they have these economic forecast to help justify significant changes in monetary policy.  

Strong opposition to negative interest rates

Local politicians, banks and insurance companies across Japan are strongly opposed to deepening negative interest rates.  

The BoJ’s move to cut interest rates from zero to -0.10% in January 2016 continues to be widely criticised by Diet members and Japanese financial institutions. A further rate cut, or indeed a further lowering of the 10-year government bond yield target this time around would have sparked strong opposition. That said, once the upcoming data becomes available – and if it is indeed more supportive of stronger easing – then a cut to the deposit rate hike may still be considered at the BoJ’s next meeting in October.

Goal: a positively sloped yield curve

It is no secret that the Bank of Japan is keen to pursue a positively sloped yield curve.   

The central bank’s Comprehensive Assessment of monetary policy and its adoption of Yield Curve Control in September 2016 was a big move for the Bank of Japan. It signalled a shift by policymakers towards mitigating the impact of negative interest rates on financial institutions by aiming to keep Japan’s yield curve positively sloped.

Had the Bank of Japan made the call to cut interest rates in their September meeting, it is possible that this would have had counter-productive results. The chance of it pushing yields on 10-year government bonds further lower from current levels (around -0.20% to -0.30%) would have been likely.

Is stronger easing on the horizon? Potentially

BoJ board member shift is required

At present, only three out of the central bank’s nine board members appear to favour stronger monetary action. At next month’s meeting however, there is a chance that the majority could shift. If Governor Kuroda and Deputy Governor Amamiya – the governor’s key ally on the board – were to favour stronger easing measures, then the three pro-easing board members would likely join them in forming a majority. That said, both Kuroda and Amamiya currently favour pursuing the current Yield Curve Control framework as a long-term strategy to help reflate the economy rather than considering more radical measures.  

Spike in yen or fall in Nikkei stock market

We do believe that if the yen were to suddenly spike, or we were to experience a major decline in the Nikkei, the BoJ is very likely to shift more towards stronger easing, particularly in accelerated asset purchases. And in a recent trip to Japan, local investors also supported this view. They told us that, in the event of a major shock to global financial markets, there is potential for a spike in the yen. So this risk is certainly on the table.

What to expect in at the BoJ October meeting

The biggest change next month would be for policymakers to lower the deposit rate deeper into negative territory from -0.10%, while keeping the ten year government bond yield target around zero. This could steepen the yield curve if long-term interest rates don’t sink as they did in 2016, when the central bank first cut its deposit rate below zero. But it would still be very unpopular in Japan.

If the BoJ decides to be less aggressive next month, we think it will widen the permitted trading band around zero percent for ten year bond yields. We also expect them to supply funds to commercial banks at negative interest rates to spur lending in the broader economy.  The financial market impact of this would be less than if the BoJ were to cut benchmark interest rates, but would still keep the yen from strengthening against the dollar to the benefit of Japan’s exporters.

Monetary policy
People's Bank of China
Fixed income
Market sentiment

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