Is This The Beginning Of The End?
BMI View: The Bank of Japan (BoJ) policy board in its latest meeting decided to employ extreme measures in a bid to stoke inflation as demanded by Prime Minister Shinzo Abe. With unanimous support to double the monetary base in two years, we believe the central bank has shown that it will employ all its tools to achieve inflation, and is likely to 'succeed'. That said, we maintain our view that inflation will not be beneficial to the economy, and believe that the latest steps of debt monetisation are likely to hasten the arrival of a debt crisis.
In the inaugural meeting of his term on 3-4 April, the new Bank of Japan (BoJ) governor Haruhiko Kuroda managed to steer the board to support the bold changes that were not approved in the last meeting under ex-Governor Masaaki Shirakawa in March. These include more than doubling the purchases of Japanese government bond (JGB) to JPY7.5trn per month on top of the consolidation of these purchases under the Asset Purchase Programme (APP) and rinban operations (which involve the outright purchasing of bonds targeted at providing funds to the economy through the increase of banks' reserves). Moreover, the BoJ changed its operational target, a measure by which it guides its money market operations, to the size of monetary base from its previous use of its policy rate (uncollateralized overnight call rate). With this new operational target, the central bank pledged to grow its monetary base by JPY60-70trn annually, a move which is set to almost double the current base in two years.
|JGBs To Further Dominate The BoJ's Balance Sheets|
|Japan - Assets On The Balance Sheets Of The Bank Of Japan, 2012 & 2014 (RHS)|
This Time, They Mean Business
By consolidating the various schemes under which the BoJ purchase assets, the it has suspended the bank note principle, a rule that was meant to prevent the bank holding more long-term JGBs than the size of banknotes in circulation, essentially meant as a safeguard preventing the outright financing of fiscal deficits. This change is very significant as it is a clear sign that the BoJ is no longer concerned with the concept of monetising the government's debt.
Be Careful What You Wish For
With all the money printing, we believe that inflation will come eventually as the government spends money into the economy via its large fiscal deficit with the help of the BoJ. However, we maintain our view that inflation will do more harm than good for the Japanese economy. Under the best case scenario, the excess liquidity pumped in by the BoJ will help boost economic activity, raising tax revenues and allowing the government to cut spending and reduce its deficit while interest costs remain relatively low. However, this is a highly likely scenario. Any rise in economic activity and inflation expectations is likely to lead to a rise in bond yields. This will choke off private sector economic activity, and raise debt servicing costs for the government. Although the government's weighted average cost of capital will rise only slowly at first in response to rising bond yields, as we have seen in peripheral Europe, investors are likely to act to push up yields sooner rather than later as the chances of fiscal consolidation become increasingly remote. This is likely to put the BoJ in an unenviable position of having to ramp up bond buying to keep yields low, at the risk of fanning inflationary pressures and collapsing the currency, or reducing its support for the government's fiscal largess.
|Not Everyone Is Confident...|
|Japan - 10-Year Government Bond Yield, %|
On The Road To Debt Monetisation/Restructuring
Although yields for government bonds of 10-year maturity and beyond move sharply lower on news of the BoJ announced its bold monetary easing plans, the next trading session (on 5 April) saw yields stage a sharp reversal. In our view, this U-turn marks a watershed moment for the JGB market, and we expect to see yields rise from here. Once inflation expectations begin to rise, it will be immensely difficult to reverse these in the absence of a default, which is increasingly becoming the most likely medium-term scenario.