Rates View: Shift in BoJ target unlikely – Speculation that the BoJ will adjust its policy of yield curve control following the end of its two-day meeting tomorrow has continued to fuel a rise in government bond yields in Europe and the US. The policy aims to ‘purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around zero percent’. In order to achieve that aim, the BoJ will conduct ‘an annual pace of increase in the amount outstanding of its JGB holdings of about 80 trillion yen’. Rumours have mounted that the BoJ could effectively increase the yield target and/or signal a lower purchase pace. The rationale for a change is mainly related to concerns of the side effects of the BoJ’s policies, particularly for regional banks, a number of which could start to make structural losses if it continues with its current policy stance. The speculation has hit global fixed income markets on the view that a narrowing of yield spreads versus Japan could lead to flows back into JGBs from markets outside Japan.
We do not expect a change at this stage. A change in the communicated increase in the balance sheet target could make sense on the surface, given that the BoJ has fallen well-short of it, reflecting that up until recently (before the speculation started), it needed to purchase less JGBs to meet the target. However, we think the BoJ will want to avoid giving the wrong signal to financial markets, even if it is a cosmetic change (given it has a price rather than quantity target in any case). More fundamentally, we think it would be pre-mature to change the yield curve target at this stage. Though wage growth and core inflation have been heading broadly in the right direction, they remain at low levels and inflation is still not on track to sustainably meet the BoJ’s target. The chance of a shift is greater in the autumn, and investors will be watching the central bank’s communication carefully for any sign it is becoming more concerned about the negative side effects of its policies. (Bill Diviney & Nick Kounis)
Euro Macro: Inflation likely flat in July – Early July inflation data from Germany (stable at 2.1%), Spain (steady at 2.3%) and Belgium (which edged up to 2.2% from 2.1%) suggest that eurozone inflation was likely also stable. This would also be in line with the consensus, for an unchanged rate of 2%. However, looking at the details, it looks as if the risks to the consensus forecast for eurozone core inflation (a rise to 1% from 0.9%) are skewed to downside. Indeed, we expect core inflation to have remained unchanged. We think underlying inflationary pressures remain weak and that core inflation will likely rise more slowly than the ECB expects in the coming quarters. (Nick Kounis)