Opinion | Why the Bank of Japan could still shock markets

Central bank chief Haruhiko Kuroda is realising that quantitative easing may be damaging investor and business psychology, and he may get the opportunity to tighten monetary policy should Prime Minister Shinzo Abe step down because of deepening political woes

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An electronic stock indicator at a securities company in Tokyo. The BOJ holds more than 75 per cent of exchange-traded funds and 45 per cent of government debt. Photo: AP

Published: 12:00pm, 6 May 2018Updated: 10:30pm, 6 May 2018

As a political noose tightens around Japanese Prime Minister Shinzo Abe’s premiership in Tokyo, investors are buzzing about something else tightening – Japanese monetary policy.

No, not because the Bank of Japan is getting closer to 2 per cent inflation – it is only about halfway there. And not because growth is exceeding expectations. Gross domestic product may have slowed to 0.5 per cent in the first quarter from 1.6 per cent in the fourth. Based on these two realities, one could argue the BOJ should hold steady or even hit the liquidity gas.

Two other factors have markets guessing. One, scandals that may oust Abe deepened in recent days. With Abe out of the way, the BOJ would have more latitude to change course. Two, the central bank is admitting it lacks sufficient tools to morph Japan’s deflationary mindset into a more confident one warranting higher consumer prices.

Any step back by the BOJ would hit global markets hard, sending the yen skyrocketing and the Nikkei 225 Index lower. The same goes for punters borrowing cheaply in Japan and reinvesting that cash in higher-yielding assets from New York to New Delhi, the “carry trade”. Coming in sync with the Federal Reserve’s intention to raise US interest rates three or four times this year, a stingier BOJ would be quite the blow to markets. It is a risk that cannot be ignored.

Japanese Prime Minister Shinzo Abe is struggling to explain how public land was sold to a school company tied to his wife at an 86 per cent discount. Photo: AP

On April 27, BOJ Governor Haruhiko Kuroda effectively abandoned his quest for 2 per cent inflation by a certain date, a target first offered in 2013. It was the sixth time at least that the date has been delayed, and is a stark reminder that the fallout from Japan’s lost decades persists. Even though Tokyo is enjoying its best run of growth since the 1980s and corporate profits are buoyant, wages are stagnant. Household spending fell by 0.9 per cent in February, according to the most recent data available.