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Categorized | Currencies

BoJ doubling down or retreating on policy?

Posted on September 21, 2016

Japanese 10,000 yen banknotes and coins of various denominations are arranged for a photograph in Kawasaki, Kanagawa Prefecture, Japan, on Wednesday, Feb. 24, 2016. The yen headed for its first weekly decline since January, paring its biggest monthly advance since the global financial crisis, amid improving risk sentiment as Group-of-20 policy makers meet in Shanghai. Photograph: Akio Kon/Bloomberg©Bloomberg

The Bank of Japan’s keenly anticipated policy meeting saw officials vowing to overshoot their 2 per cent inflation target and keep yields on benchmark 10-year government bonds at zero.

The changes whipsawed the Japanese yen, buoyed equities and provoked sharply different reactions among investors on whether the central bank was doubling down on its stimulus policy or quietly retreating from it.

    How big a deal are the changes?

    It depends who you ask. Analysts at Goldman Sachs reckon that, taken together, the changes amount to a cogent rebuttal of fears the BoJ’s ¥80tn-a-year ($795bn) quantitative easing programme has run out of steam.

    “The ‘inflation overshoot’ language is a fundamental and dovish change” that sets “the stage for QQE infinity”, they said.

    Not true, according to strategists at Deutsche Bank. The changes can be comfortably filed into the “fiddling around the edges” folder, they say, as it will do little to either drive inflation higher or accelerate economic growth.

    What did the yen’s reaction tell us?

    If you looked only at the instant reaction, it suggested Haruhiko Kuroda, the BoJ governor, had impressed investors with bold changes. The yen, which has confounded investors with its strength this year, fell as much as 1.1 per cent to ¥102.79 against the dollar.

    However, that weakness had evaporated by the end of the London trading day as investors questioned whether the policies will be enough to rattle the currency’s resilience.

    Analysts at Bank of Tokyo Mitsubishi cautioned that nothing the BoJ delivered makes them turn “suddenly yen-bearish”. Indeed, “without a shift in market scepticism over lifting inflation expectations, the yen is set to advance further”.

    Yunosuke Ikeda, Nomura’s forex strategist, said the situation for the yen remained finely balanced, with much depending on the behaviour in coming days of the Japanese life insurers as traditional drivers of dollar-yen.

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    Mr Kuroda’s “sneaky move” of adding yield curve control to its continued commitment of annual JGB purchases, said Mr Ikeda, meant that it “was just a matter of time before economists and strategists start to believe that the BoJ has opened the gate to tapering”.

    If the financial institutions in Japan take comfort in that and start to believe the BoJ policy is not going to hurt them, they may be happier taking on more risk — a move that could see them increasing purchases of dollar-denominated assets and weakening the yen.

    The other big driver, of course, will be how foreign exchange markets react to the Federal Reserve.

    Are investors now more confident about the BoJ hitting its inflation target?

    Not really. The 2 per cent inflation target has proved elusive for the central bank and it appears to be a minority camp who believe the changes will help them overshoot it.

    Martin Sandbu’s Free Lunch

    BoJ toolbox remains full

    Bank of Japan (BOJ) Governor Haruhiko Kuroda attends a news conference at the BOJ headquarters in Tokyo, Japan, September 21, 2016. REUTERS/Toru Hanai

    Central banks must find the will to use their power

    Economists at Daiwa argue that, without a “much larger fiscal boost” from the government, then the BoJ is likely to fall short of its ambitions.

    Keith Wade, chief economist at Schroders, said that, by pledging to overshoot the inflation target, the BoJ has effectively told investors more stimulus is coming.

    “That does not mean it will fail, only that more action will be needed and we would look for a rate cut at the next BoJ meeting on November 1.”

    Who were the early winners from the change?

    There is an easy answer: embattled financial stocks. The BoJ’s decision not to cut its benchmark interest rate deeper into negative territory was welcomed by investors who have been anxious that negative rates will erode lenders’ profitability.

    The Topix Banks index, home to the shares of Japan’s largest lenders, closed almost 7 per cent up at its highest level in six months. By late afternoon trading in Europe, the Euro Stoxx Banks index, a gauge of European bank stocks, had risen almost 3 per cent.

    In a measure of how badly they fell out of favour in the first quarter of the year, the Topix Banks index remains down 24 per cent this year. The Euro Stoxx Banks index is 26 per cent weaker for the year.

    “The BoJ’s decision to keep its short-term interest rate unchanged and steepen the yield curve is definitely positive for financial sectors such as banks and insurance,” said Hiroyuki Ito, portfolio manager of the Fidelity Japan Fund.

    The moves in financial stocks were enough to help the wider Japanese stock market, with the benchmark Topix index finishing 2.7 per cent stronger. Meanwhile, the Euro Stoxx index was up 0.6 per cent.