Japan ploughs its own furrow as end of cheap money fast approaches
The Bank of Japan was the odd man out at last week’s gathering of central bankers in Portugal, and with good reason
Some investment strategists are already dubbing it a “mini taper tantrum”.
Last week’s abrupt sell-off in government bond and foreign exchange markets in response to hawkish comments from the European Central Bank, the Bank of England and the Bank of Canada has drawn parallels with the turmoil engendered by the US Federal Reserve’s unexpected decision four years ago to begin scaling back, or “tapering”, its programme of quantitative easing.
The price action last week was certainly sharp. The yield on benchmark German, British and US 10-year debt shot up 22, 24 and 17 basis points respectively while the dollar index, a gauge of the greenback’s performance against a basket of other currencies, fell a further 1.8 per cent to its lowest level since early October as investors speculated that other central banks would shortly join the Fed in tightening policy.
The hawkish rhetoric even prompted some analysts to talk of a coordinated effort on the part of the developed world’s major central banks to prepare markets for the withdrawal of stimulus.
Not so fast.One large central bank – and the most aggressive quantitative easer to boot – was conspicuously silent on the sensitive issue of tightening policy.
The Bank of Japan was the odd man out at last week’s gathering of central bankers in the Portuguese resort of Sintra, and with good reason.
While the ECB – the focal point of market anxiety about the end of quantitative easing due to comments by president Mario Draghi about the growing strength of the euro-zone recovery – can at least point to a headline inflation rate that, while still below its target of 2 per cent, has risen to 1.3 per cent, having barely been in positive territory last summer, the BOJ is not even close to meeting its 2 per cent target.
Japan’s headline inflation rate, which was still negative as recently as September, has been more or less stable since the beginning of this year, remaining at 0.4 per cent year on year. The so-called “core-core” rate, meanwhile, the preferred measure of the BOJ, which excludes all volatile food and energy prices, is stuck at zero, unchanged from a year ago and significantly lower than the 1.1 per cent rate in the euro zone.
While the BOJ, which caps Japan’s 10-year bond yield at close to zero and continues to buy assets at a brisk pace of 80 trillion yen a year, is taking comfort from an economic recovery that has delivered five consecutive quarters of growth and has pushed unemployment down to below 3 per cent, wages are barely rising, restraining consumer prices despite four years of aggressive stimulus.
Governor Haruhiko Kuroda insisted at the central bank’s policy meeting last month that he was determined to maintain asset purchases until inflation approached 2 per cent, stressing that to announce an exit strategy from quantitative easing at this stage “would invite market confusion” and was “not appropriate”.
Indeed even the International Monetary Fund, in its latest assessment of Japan’s economy published on June 19, recommended that “monetary policy should maintain a sustained accommodative stance” given that “inflation remains stubbornly low”.
If the Fed is leading the push towards policy normalisation and the ECB is slowly moving towards the tightening camp, then the BOJ is the standard-bearer for the continuation of ultra-loose monetary policies.
The BOJ’s uber-dovish stance has significant implications for markets. Not only is Japan the world’s second-largest government bond market, it also accounts for more than 60 per cent of the global stock of negative-yielding sovereign debt, according to JPMorgan. With the BOJ likely to keep its foot firmly on the monetary pedal for some time yet, “yield refugees” from Japan will continue buying higher-yielding US and European bonds, exerting downward pressure on borrowing costs in the face of tighter policy.
It is also unclear whether the BOJ will be the only major developed-market central bank to resist tightening.
Core inflation in the euro zone is still roughly half the ECB’s target. Europe’s monetary guardian even had to inform the press last week that investors were jumping the gun in assuming that the ECB was about to tighten policy. The persistent fear on the part of central banks that the withdrawal of stimulus will trigger a disorderly sell-off that will damage the global economy could end up prolonging monetary accommodation, possibly much longer than central banks would like.
Hardly surprising, then, that Kuroda is keeping mum.
Nicholas Spiro is a partner at Lauressa Advisory