- BoJ stuck to its easing course for now, but likely to step up in June or July…
- …with stimulus extended through 2015, with purchases of JGBs, ETFs, CP and corporate bonds
- Unrest in Eastern/Southern Ukraine flares up in the run-up to May presidential elections
No action now…BoJ likely to take action in June or July
This morning the Bank of Japan (BoJ) left monetary policy unchanged as widely expected. The BoJ maintains their view that the economy will continue to recover moderately as a trend with some fluctuations due to the consumption tax hike. Inflation excluding the direct effects of the consumption tax hike is likely to be around 1.25% for some time. The central bank reiterated that they will continue with quantitative and qualitative monetary easing to achieve the price stability target of 2% in a stable manner. We judge that the BoJ needs to increase monetary stimulus to achieve the 2% inflation target by end fiscal year 2014 or early fiscal year 2015. According to the BoJ, core inflation is expected to rise by 1.7pp in April and 2pp in May after the consumption tax is raised. However, the rise in core inflation is expected to drop off after April 2015 due to base effects. As such, stronger economic growth, higher wages and reforms need to be implemented to ensure that the rise in core inflation is sustainable. We judge that the BoJ will wait until the summer to have a better assessment on the impact of sales tax on economic growth before taking further actions. The monetary policy meeting on 14 July, a date when the central bank will give its interim assessment on the economy, is likely to be a suitable time for the central bank to announce further monetary stimulus as the central bank would have a better picture on economic growth in the first quarter and business outlook for the rest of this year. However, we do not rule out that the BoJ could move earlier in June should they choose to take a more proactive stance and maximise the stimulus effects by surprising the market. Indeed, according to a Bloomberg survey in March, a majority of economists polled expect the BoJ to increase monetary stimulus by the end of Q3 this year.
Possible measures BoJ could take
The BoJ is likely to extend the time frame to achieve its 2% inflation target till the end of fiscal year 2015. In order to achieve this, we believe that the BoJ is likely to increase its monetary base by 60-70 trillion yen annually into 2015 (from current end 2014). The majority of monetary stimulus is likely to be focused on Japanese government bonds (JGBs). As the current average maturity (around 7 years) of the BoJ’s JGB purchases are equivalent to the average maturity of the amount outstanding JGBs issued, we think there is little scope for the BoJ to increase its duration risk. In addition, purchases of super long maturities could potentially impact the returns of pension funds and life insurance companies. Given constraints in the market size of J-REITs, increases in ETF, CP and corporate bonds purchases are also more likely. More aggressive measures such as purchases of foreign currency bonds will only be implemented as a last resort. We also believe that the BoJ is unlikely to increase the pace of its monthly JGB purchases substantially to avoid market concern that it is financing the fiscal deficit.
Ukraine accuses Russia of stirring unrest in the East
Political unrest in Eastern/Southern Ukraine has flared up again recently. Pro-Russia protests continued in large cities such as Donetsk, Kharkiv and Luhansk, but for the first time protests also spread to smaller cities. On Sunday, several thousands of demonstrators occupied provincial government headquarters in Donetsk and Kharkiv and local headquarters of the Ukrainian security service in Luhansk and Donetsk. The general tendency of these movements is to call for referenda on federalisation and secession from Ukraine. On Monday, activists declared the creation of an independent ‘People’s Republic of Donetsk’. The unrest will likely continue or even intensify in the run-up to, and possibly also the aftermath of, the presidential elections scheduled for May 25. The Ukrainian authorities have accused Russia of having a role in the recent turmoil, claiming that Russia is looking for destabilisation and division of Ukraine, while pointing to the large number of Russian troops at the Ukrainian borders ready to step in. Should Russia indeed intervene further in Ukraine, the West will likely introduce ‘stage 3’ economic sanctions targeting the Russian economy directly (on top of the ‘stage 2’ sanctions directed at individuals currently in place). However, we still deem a full ‘Iran-style’ energy blockage unlikely, particularly given the EU’s strong energy ties with Russia. The unrest caused renewed pressures on the ruble and the Russian stock exchange.