BoJ Watch – The surprise ease

by: Roy Teo

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The BoJ surprised the market by expanding its quantitative and qualitative monetary easing (QQE) programme earlier than expected. The monetary base will increase at an annual pace of about 80 trillion yen from current pace of 60-70 trillion yen, with a focus on JGBs. The average duration has also been lengthened from current 7 years to 7-10 years. The QQE programme will be an open ended programme as long as it is necessary to maintain the price stability target of 2%. We expect the yen to decline to 115 and 125 against the US dollar by the end of 2014 and 2015, respectively.

Expansion of QQE programme

In our BoJ Watch “More easing on the cards” published on 30 October, we highlighted that there is a strong case for the Bank of Japan to further ease monetary policy later this year. This was earlier than market consensus expectations of first quarter of 2015. Earlier today, the BoJ decided to take action even earlier by announcing an expansion of the quantitative and qualitative easing programme so that the monetary base will increase at an annual pace of about 80 trillion yen from the current 60-70 trillion yen. The bulk of the increase will be focused on Japanese Government Bonds (JGBs) with their amount outstanding increasing at an annual pace of about 80 trillion yen, a 30 trillion yen increase. The average remaining maturity of the JGB purchases will also be extended to about 7-10 years from current 7 years. Purchases of Exchange Traded Funds (ETFs) and Japanese Real Estate Investment Trusts (J-REITS) will also be increased.

 Prevention of deflationary mind set

Since the BoJ announced the QQE programme in April 2013, core inflation has risen from -0.4% yoy to 1.5% (excluding the effects of VAT hike) in April this year, before trending lower to 1.0% in September. The downward pressure in recent months was due to weak developments in demand following the consumption tax hike in April this year and decline in crude oil prices. To mitigate the risk of a deflationary mind-set setting in, the BoJ decided that further actions were necessary sooner than later to firm inflation expectations and provide a boost to economic growth.

 2% inflation target only in 2016

As highlighted in our Japan Watch “GDP growth revised down” published on 29 October, we expect inflation excluding the effects of VAT hike to rise modestly to 1.6% in 2015. This is not materially different from the BoJ’s new forecast of 1.7% in Fiscal Year 2015. We assume that the consumption tax will be raised from 8% to 10% in October 2015. Given that the 2% inflation target will only be achieved in 2016, we think it is highly likely that monetary policy conditions in Japan will remain very accommodative over the coming year.

Japanese yen outlook

Since the BoJ monetary policy decision earlier today, the Japanese yen slumped by more than 2 yen to 111.50 at the time of writing. Though short term technical indicators imply that the yen is oversold, we think that any correction (strength) in the yen will be limited given that the BoJ decision today was not fully priced in by the market. Furthermore, we expect Japanese life insurers to take advantage of any periods of yen strength to position for more overseas assets purchases as domestic bond yield returns are expected to underperform. The Government Pension Investment Fund with total assets of about USD 1.2 trillion has also announced today that they will raise their foreign bonds and stocks target to 15% and 25% respectively. As of end June 2014, international bonds and stocks account in turn for about 11% and 16% of total assets. This is expected to weigh on the yen. Last but not least, as we expect interest rate differentials between the US and Japan to widen well into 2015, the yen is projected to decline to 115 and 125 against the US dollar  by the end of 2014 and 2015.

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