August 1, 21:00 JST, 2016

BoJ to partially retract its inflation target in September

For a printable version of the report, please click here.

We think the BoJ is likely to remove the time limiting part of its inflation target framework at its next policy meeting in September. In the policy statement the bank published last Friday, it said,

the Bank will conduct a comprehensive assessment of the developments in economic activity and prices under "QQE" and "QQE with a Negative Interest Rate" as well as these policy effects at the next MPM.

Judging from the way the BoJ governor Haruhiko Kuroda articulated the meaning of “comprehensive assessment” in his press conference, we believe the BoJ is considering removing the time limiting part of its inflation target framework in its September meeting.

Since the BoJ embarked on the current easing cycle, the bank has pledged to accomplish its 2% inflation target in “about two years”. In the policy statement it published in April 2013, it stated,

The Bank will achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years.

The deadline was initially understood to be the end of FY2015. In November 2014, when the BoJ admitted to delay the deadline, it expanded its monetary easing measures. Since then, every time the BoJ had to delay the deadline, the financial market is led to expect the BoJ to expand its monetary easing. The market was duly disappointed in April 2016, when the BoJ did not ease despite having to admit that it had to delay the deadline for its inflation target. The likely change in September should stop this constant clamoring for additional easing. The BoJ will most likely the pledge to achieve its inflation target “at the earliest possible time”, but remove the reference to specific time frame the Bank expect the target to be achieved in. 

How will the change affect Japan’s monetary policy?

After September, the 2% inflation target will become a medium term target for the BoJ. The BoJ will no longer be expected to constantly expand its monetary easing while the inflation target remains unmet. In our view, the change is overdue. As we wrote in September 2015, we had noticed that the BoJ had already changed the nature of its pledge in late 2015. However, it failed to communicate the change clearly to the market which led to unnecessary volatility in the financial market.

We also think that the change is inevitable, as we believe the BoJ has nearly exhausted its means to ease the monetary condition in Japan. While there are still some measures the BoJ could implement, the cost of adopting these measures outweigh the benefits they bring. In our view, expanding its ETF purchase to 6 trillion yen was one such measure. At the new pace of the purchase, the exposure of the BoJ to equity market will quickly grow to such an extent that a severe negative shock could wipe out the banks' capital by early 2018. For more details on our view of the limitation on the BoJ, please see our recent report, Time for Damage Control.

Bank of Japan's Balancesheet

While we think the retraction of the time limit is inevitable and for the better, the financial market will probably react negatively. The BoJ could come up with some innovative ways to soften the blow though. In our view, introducing a forward guidance on its monetary policy path “after” achieving its inflation target is one possibility. Reaching an accord with the government to encourage larger fiscal stimulus could be another. We will see if the BoJ provides some hints for the new twist to its policy framework in the coming weeks.