BoJ Preview: Plumbing the depths of negative interest rates - RBS

Jin Kenzaki, Senior Economist at RBS, suggests that in today’s BoJ Monetary Policy Meeting (MPM), a “comprehensive assessment” will be carried out of economic and inflationary trends under current monetary policies and the effectiveness of those policies.

Key Quotes

“Based on Governor Kuroda’s speech last week on the 5th, we expect the review to show that (1) the failure to achieve the 2% inflation target was due to external factors such as the drop in oil prices, the rise in the consumption tax, the slowdown in developing economies, and the instability in international financial markets, as well as the adaptive formation of inflationary expectations; and (2) the quantitative and qualitative easing with negative interest rates has had a pronounced effect, but also to some degree has negatively impacted liquidity in the financial markets and profitability of financial institutions.

In our view, the above conclusions should lead to no change in the framework for quantitative and qualitative easing with negative interest rates. The BoJ will stick with its current framework for quantitative and qualitatively easing with negative interest rates, albeit possibly with some technical changes based on consideration of the adverse effects of negative interest rates.

The 2% inflation target, on the other hand, is likely to undergo some fine-tuning. First, it is highly likely that the policy to reach 2% as soon as possible will be retained, but effectively abandoned by an objective to reach it in two years. Second, the stance of emphasizing BoJ-style core CPI, overall inflation excluding fresh food and energy, may be made explicit.

A decision to ease further?

Important factors in discerning whether MPM will decide on additional easing include (1) concerns about the Chinese and European economies as compared to the July MPM; (2) the possibility that the FOMC meeting in September could raise rates; and (3) the current inflationary situation in Japan.

Concerns about the Chinese and European economies have grown less than expected at the time of the July meeting. Were one to stress these points, it would point to a possible delay in additional easing. However, we foresee additional easing steps based on the facts that (1) BoJ-style core CPI is currently showing a broad decline in goods and services; (2) inflation expectations continue to be moderate even after the introduction of negative interest rate policies; and (3) the likelihood is low that the Fed will move to raise rates in September.

Risk scenario

If Governor Kuroda maintains his past stance of insisting on surprises, it is not inconceivable that at the policy meeting he might announce the risk scenario of a shift to targeting long-term rates. A reduction in buybacks of government bonds could spur a spike in long-term rates. Considering the collateral requirements for financial institutions, the limits to increasing government bond buybacks are fast approaching. A shift to targeting long-term rates, however, could allow government bond buybacks to be reduced while holding back increases in long-term rates. Our main scenario is that such a shift would occur in 2017 or beyond when the limits to government bond buybacks edge even closer, but there is some small possibility that it could be decided at next week’s meeting.”