The Bank of Japan (BoJ) surprised no one when it held off implementing more stimulus yesterday, but the level of positivity in their comments was interesting. October is now the month traders are betting on for the BoJ to act, but how likely is this?
BoJ Governor Haruhiko Kuroda chose not to add to the already mammoth stimulus package that has been pumped into the markets over the past yearand maintained confidence that inflation was on track to meet the bank’s 2% target. He said: “Our quantitative easing policy is exerting its intended effects,” also saying that the economy would emerge from a temporary slowdown in activity caused by April’s sales tax, describing the effect of the tax as “mild”.
The BoJ also revised up itscapital expenditureassessment, which is a crucial driver of Japan’s growth.“Capital expenditure has increased moderately as corporate profits have improved,” the bank said. It also believes that gains in capital expenditure are sustainable as capacity constraints will be felt by more businesses. This can be seen in the recent wage price growth and the increase in machinery orders. A sustained improvement here is likely to lessen the chances of further monetary easing.
This can also be seen in the output gap. The output gap is the difference between the actual and potential GDP of an economy, and a large negative gap indicates inefficiency as labour and capital remains idle, causing the economy to produce below capacity. A large positive gap leads to inflation as an economy produces more than its capacity. According to a preliminary estimate by the BoJ, the output gap closed to near zero in the first quarter, having been negative for the past 7 years. The below graph shows the relationship between inflation and the output gap with estimates for the next two years:
Japan Output Gap (White) vs CPI (Yellow) 1987-2016
Preliminary GDP figures released last week show Q1 GDP increased 1.5% from the previous quarter. This is an annualised pace of 5.9%. At first,this looks like the vindication the BoJ and Abe are after, however, don’t be fooled. This figure includes the effect of people binge buying and hoarding before the sales tax came into effect at the beginning of April. What is important is that the market was expecting 1.0% growth, which obviously took into account the sales tax because Q4 2013 growth was a mere 0.2%, so the 0.5% overestimates could be attributed to these policies.
Kuroda also said there is no reason for theYen to rise and exchange rates are not a target of the policies but they will have an effect on the exchange rates. The Yen has depreciated heavily since Shinzo Abe came into power, breaking through the 85 Yen per dollar mark to its current level of 101.52. Further easing is likely to send the Yen up to the 108-110 level, which in turn has an effect on the economy and the decisions the BoJ makes. A weak Yen increases prices for imports, impacting inflation, and it makes exports more attractive to trading partners, increasing demand for local products and therefore inflation. So whether Kuroda cares or not about the Yen, it has a direct impact on what he is trying to achieve.
USD/JPY Weekly
Yesterday,Kuroda said: "The Bank of Japan will continue with this policy until the 2 percent target is achieved in a sustained manner."The plan all along was to have a second round of stimulus sometime this year, the question has become ‘when?’. The BoJ will wait until the sales tax has worked its way out of the data before it looks about implementing its next round of stimulus. In their July meeting, they will be assessing data from after the sales tax came into effect. They probably will not act on one set of data alone unless it was looking really grim, so October will be the month the market will be looking at.
There are certainly some positive signs for the Bank of Japan to be positive about and it is easy to see why the stimulus was put on hold for now. The crucial data will come out in July and the market will be scrutinising that for signs of weakness and anything else that might point to the BoJ acting. Until then, along with the BoJ, we play the waiting game.