October 30, 2015, 22:00 JST

BoJ and its road mirage inflation goal

BoJ kept its policy unchanged as it concluded its two days policy meeting on October 30. In our view, the decision was in line with what the governor Kuroda has been trying to communicate over the past few months. As we wrote here 3 weeks ago, he was fairly explicit in downplaying the chance of any near term easing in the press conference he gave 3 weeks ago. 

"Then, why did so many economists expect an easing this time?"

In our view, there were two major source of miscommunication between the BoJ and the market. First, many analysts did not realize that the BoJ is no longer committed to achieving its 2% inflation target by a set deadline. Many economists argued that the BoJ would need to ease today as the BoJ admits that it is unlikely to achieve its inflation target in the first half of 2016. Instead, the BoJ was happy to just blame the low international energy prices and shift "the expected" period when the bank attain its inflation goal to the second half of the fiscal year 2016. The 2% inflation target has become a road mirage and the BoJ seems perfectly fine with it. Do not be surprised if the BoJ decides to shift it again to the first half of fiscal year 2017.

The second source of the miscommunication is the mis-impression that governor Kuroda likes "surprises". His Halloween easing last year was perceived as such an attempt. Thus, no matter how explicitly the governor Kuroda tried to persuade the market this time that the BoJ was unlikely to ease, the financial commentators ignored what he said as an attempt to deceive them. While the market can improve its skill to read the BoJ, this perception that a central bank governor could be intentionally trying to deceive the market is a dangerous one. The BoJ should try to dispel such image and establish more transparent method of communication. In our view, the mis-communication is mostly the fault of the BoJ and the governor Kuroda though. When the BoJ eased in October 2014, it kept saying that they are easing because of the lower energy prices when in fact the real reason was to counter the negative impact from the sales tax hike in April 2014. In our view, the governor Kuroda really needs to rethink his communication strategy lest the BoJ loses its ability to effectively influence the market.

What are the chances of an easing in the coming months?

We think the hurdle for an additional monetary easing is pretty high. According to the BoJ, there is a moderately accelerating inflationary pressure building up in Japan. The CPI excluding fresh food and energy, the proxy for the underlying inflation trend preferred by the BoJ, rose to 1.2% in September, up from 1.1% in August and 0.4% at the beginning of 2015. 

It seems that the BoJ is content to wait and see if the inflation manages to rise to 2% in the next 12-18 months. In our view, however, the BoJ is wrong to think it has time on its side to patiently wait for a desirable inflation to emerge. The assumption that the economy will keep on growing without a disruption seem too naive for us. The last global recession ended 6 years ago and a major downside risk could be around the corner. Once the economy start to point downward, it will be virtually impossible to achieve its 2% inflation target amidst an economic downturn. Another reason why the BoJ needs to achieve its inflation target sooner rather than later is its accumulation of JGBs. At the current pace, the market share of the BoJ in the JGB market will exceed 50% in early 2018. In our view, the BoJ should be more aggressive in achieving the inflation target while it has a chance.    

Is the BoJ concerned on the upside risk?

In this regard, there was one interesting question reporters posed to the governor Kuroda in the press conference today. A reporter asked if the BoJ is concerned about the risk that inflation could be excessive. The governor Kuroda did not seem to have a prepared answer for it. He murmured, and basically repeated that the BoJ is currently striving to reach its 2% inflation target from below. In our view, we do not think the BoJ is much concerned about an upside risk. The reason the BoJ is hesitating from an additional easing is that the BoJ thinks that there is no need to hurry and it can wait. While we hope the BoJ gets its wish, the BoJ is making itself and the Japanese economy increasingly vulnerable to a downside risk.