Japan: BOJ reinforces YCC commitment
BOJ meeting review; GDP forecast downgrade
Group Research - Econs, Ma Tieying28 Apr 2022
  • The BOJ reinforced commitment to the yield curve control policy framework at today’s meeting
  • Governor Kuroda reiterated the view that a weak yen is positive for the Japanese economy as a whole
  • Energy-driven inflation is seen as a temporary phenomenon in Japan
  • Growth risks remain the major factor influencing policymaking
  • We are further lowering the 2022 GDP growth forecast to 1.6% from 2.2%
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BOJ reinforces YCC commitment

The Bank of Japan (BOJ) kept monetary policy unchanged at today’s meeting, striking a balance between higher inflation and a weaker growth outlook. During the quarterly outlook report, the BOJ lifted the FY22 inflation forecast to 1.9% from 1.1% while revising down FY22 GDP growth forecast to 2.9% from 3.8%. For the longer term, the BOJ projects inflation to rise modestly by 1.1% in FY23 and FY24, still below its 2% price stability target.

We also think CPI will rise notably to 2% YoY in 2Q-4Q due to oil price increase and the influence of the base effect. Earlier this month, we also revised up our full-year inflation forecast to 1.6%. The 2% inflation may not be sustainable, however. The rise in cost-push inflation, which comes at a time when output has not fully recovered from the pandemic shock, and wage growth has not picked up, carries the risk of dragging the economy back into recession (and then deflation).

The BOJ also reinforced its commitment to the Yield Curve Control (YCC) policy framework at today’s meeting. It said in the policy statement that it would offer to purchase 10Y JGBs at 0.25% every business day through fixed-rate operations to implement the existing guidelines for bond market operations.

We see the room for the BOJ to maintain the YCC framework by conducting fixed-rate operations and increasing the quantity of regular bond purchases. As of December 2021, the BOJ has held about 43% of the total outstanding JGBs (~JPY530tn). This remained lower than the peak level of 45% seen after the Covid outbreak in 2H20. Going forward, should the 10Y yield persistently test the upper end of the BOJ’s ±0.25% target band as a result of a faster global yield increase, the BOJ may consider tweaking the YCC policy, such as widening the 10Y yield target to ±0.3% from ±0.25%, or shifting the ±0.25% target to 5Y yield from 10Y yield. Similar policy tweaks happened in 2018, the later phase of the 2015-18 Fed tightening cycle. Back then, the BOJ widened the 10Y yield target band to ±0.2% from ±0.1% in response to the market-driven yield increase due to higher global rates.

On the exchange rates, Governor Kuroda reiterated the long-held view that a weak yen is positive for the Japanese economy. He pledged to closely monitor the impact of exchange rate movement, recognizing that rapid movement in a short period heightens uncertainties and makes it difficult for companies to set their business plans. USD/JPY hit 130 today after the BOJ’s policy announcement, the highest in over 20 years. Year to date, the yen has lost 12% versus the dollar. The sharp rise of USD/JPY reflects the widening of the UST-JGB yield spread and the weakening of Japan’s trade balance. But USD/JPY has already exceeded the levels seen during the entire Fed tightening periods in 2004-06 and 2015-18, and during Japan’s trade deficit period in 2011-15 (earthquake disaster, energy price increase). USD/JPY has also breached the 125 peak level seen after the launch of Abenomics in 2013 (the so-called Kuroda line).

Going forward, it remains likely for policymakers to step up verbal interventions to contain the pace of yen depreciation if the yen’s volatility spikes due to a rapid global yield increase. But actual interventions to stem the yen’s decline are not very likely, in our view. Japan historically focused on arresting the yen’s rapid rise to fight deflation and maintain export competitiveness.

Yen-buying interventions only happened two times in the past three decades, respectively, during the Asian Financial Crisis in 1997-98, and the bursting of Japan’s enormous asset price bubble in 1991-92. Yen-selling intervention could be conducted by the government through issuing short-term bills to raise the yen and then sell in the market. In contrast, yen-buying intervention requires tapping foreign reserves, which is subject to the adequacy and liquidity of the central bank’s reserve assets. In Japan, the latter is mainly pursued during extraordinary times of massive capital outflows or financial crises.

Lowering our GDP growth forecast

Despite a loose monetary policy, ultra-low interest rates and a weak yen, we are further lowering our 2022 GDP forecast to 1.6% from 2.2%. This is the second downgrade this year.

Different from 2013, when Abenomics was first introduced, the net positive impact of yen depreciation is likely to be small and limited this time, in our view. This is because: 1) the yen is now cheaper and undervalued (JPY NEER is ~20% below the Dec12 level, JPY REER is at its lowest level over nearly half a century since 1973); 2) the ongoing depreciation happens at a time when global energy prices increase, which aggravates the problem of imported inflation; 3) external demand outlook is softening due to the Ukraine crisis, Fed tightening and China’s partial lockdown, which counteracts the positive effect of a weak yen on Japan’s exports. Japan has indeed been making efforts to rebuild the domestic supply chain and restore trade competitiveness in recent years, such as attracting foreign direct investment and the repatriation of Japanese companies operating overseas. But this process takes time. For instance, Taiwan’s TSMC has started constructing its first chip plant in Kumamoto this month, aiming to begin mass production by 2024. In the short term, shortages of auto chips and other parts (due to the China lockdown) may continue to constrain Japan’s export outlook.

On the domestic side, the surge of Omicron infections at the start of this year has caused a notable decline in consumer spending, which should lead to a QoQ GDP contraction in 1Q. Although the Omicron wave has passed the peak and the government has lifted the quasi-state of emergency, rolling out Covid vaccine boosters remains relatively slow (52% of the total population, as of April 26). Google mobility data showed that retail and recreation activities remained about 10% below the pre-pandemic normal levels on April 24.

Government spending is expected to continue to play an important role in bolstering growth in the near term. The parliament passed a record large annual budget in March, at JPY107.6tn. And a record supplementary budget of JPY36tn was approved earlier in December 2021. Meanwhile, the government announced an additional package to cushion the impact of rising oil and food prices on April 26, which may require the drafting of another supplementary budget worth JPY2.7tn. Considering the upper house elections scheduled this summer, Prime Minister Kishida’s government may continue to use fiscal stimulus measures to keep the economy afloat in the near term.

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Ma Tieying 馬鐵英, CFA

Senior Economist - Japan, South Korea, & Taiwan 經濟學家 - 日本, 南韓及台灣
[email protected]

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