No cutting the slack

It could be 2018 before the Bank of Japan can embark on an exit strategy to stop its aggressive monetary easing policy aimed at easing deflation

PUBLISHED : Thursday, 23 May, 2013, 12:00am
UPDATED : Thursday, 23 May, 2013, 4:27am

The Bank of Japan may end up pursuing its massive monetary easing for up to five years before achieving inflation levels conducive to unwinding its aggressive stimulus, a poll of central bank watchers suggests.

The bank aims to reach an inflation target of 2 per cent in two years, to revive an economy sucked down by years of deflation.

The prospect of it taking far longer before the bank can begin tightening stands in stark contrast to expectations in global markets that the US Federal Reserve could taper off its huge bond-buying campaign as early as this year.

A former Bank of Japan board member, Nobuyuki Nakahara, one of the 10 economists and former bank officials surveyed, said: "At this point I don't see an exit for the bank. Europe's economy is extremely weak. It is also possible that China's economy could slow suddenly."

The Bank of Japan only embarked last month on its historic programme to flood the markets with US$1.4 trillion in cash over two years to reflate a limp economy that has suffered 15 years of deflation.

Governor Haruhiko Kuroda has said it was pointless to discuss an exit strategy now. But given the operational difficulties the central bank has faced in implementing its massive easing, participants in the Japanese government bond market are already wondering when and how the bank will be able to put its strategy in reverse.

The poll, by Reuters, indicates a tough challenge. The bank is expected to stand pat at a policy meeting yesterday.

Seven respondents said the bank should begin unwinding its policy after a 2 per cent increase in consumer prices has been sustained for three to six months. Two said the bank should begin to exit once core prices rise by 1 to 1.5 per cent to avoid overshooting its inflation target.

Many respondents said they could not estimate when the bank should head for the exit, but other surveys of consumer price forecasts suggest it may take five years to achieve its price target.

This was likely to leave the Bank of Japan years behind the Fed in changing policy.

The president of the San Francisco Fed, John Williams, said last week that the central bank "could reduce somewhat the pace of our securities purchases, perhaps as early as this summer."

Dana Saporta, an economist at Credit Suisse in New York, predicts an adjustment starting in September. Masaaki Kanno, chief economist at JP Morgan Securities and a former Bank of Japan official, said he thought the central bank could begin its exit when core CPI has been rising at a year-on-year rate of 1.5 per cent for three or four months. However, he said: "At the earliest, it may take five years before core inflation reaches 1.5 per cent."

Mari Iwashita, a bond strategist at SMBC Nikko Securities, thinks it could take three years or more to meet her conditions for a tightening. She thinks the bank should consider "core-core CPI", which excludes energy prices as well as food. The core measure includes energy.

The Bank of Japan-watchers survey supports a survey by Reuters last month of 30 analysts, in which 18 said the bank will not be able to achieve its price goal within two years. Eight of 13 analysts said the bank had a chance to hit its inflation target by 2018.

The central bank itself forecasts core inflation of 1.9 per cent, excluding the impact of an expected sales tax increase, for the financial year ending in March 2016.

The Bank of Japan is the dominant player in the Japanese government bond market, so when it chooses to end its easing and begin buying government bonds it will have a huge impact on that market. It now buys 7.5 trillion yen (HK$567 billion) a month in government debt, equal to 70 per cent of new debt issuance.

The watchers said the bank was likely to start unwinding its policy by gradually lowering purchases of government debt, real estate investment trusts and exchange-traded funds. Then it would start to shrink its balance sheet, and only then raise interest rates, possibly targeting the rate it pays commercial banks for excess reserves parked at the central bank.

To reduce the securities on its books, one economist said the bank would be able to sell debt, but three others said the purchases are so large it will have to keep the debt on its balance sheet until maturity. One respondent said the bank's balance sheet may actually continue to expand.