SEPTEMBER 21, 2016, 00:30 JST

BoJ reaches the end of QQE road

The stock market may have liked the BoJ decision today as it decided to go easy on banks. However, we are doubtful if the positive market reaction would be sustained. In our view, the market should have reacted negatively, as the BoJ is effectively tapering its quantitative easing policy. We will be publishing more detailed analysis on the implication of the BoJ decision on their September 20-21 meeting later. However, here is our summary assessment.

No more two-year time-limit for their inflation target

BoJ announced that they are no longer mentioning 2 years as the benchmark duration within which they plan to achieve the 2% inflation target. In our view, this is a clear step-down in their monetary policy stance. The BoJ will not be as ardent as it has been in its effort to reflate the economy in the future.

10-year interest rate target more important than the amount of JGB purchases

BoJ announced that they are targeting 10-year interest to be around zero, and their JGB purchases will be relegated to be mere tools to achieve the target. While the BoJ mentions that the amount of JGB purchase will be broadly unchanged, this is clearly a preparation to taper, in our view.

No more duration target for their JGB purchases

Until today, the BoJ were committing to maintain the average maturity of JGBs they buy each month to between 7 and 10 years. By today's decision, the BoJ is no longer bound by this commitment. In our view, this is another sign that the BoJ is planning to taper. By purchasing long duration JGBs, the BoJ was signaling pension/insurance companies to diversify away from JGBs. It seems the BoJ no longer feels such policy nudge is necessary.

Inflation-overshooting commitment unlikely to be effective

From the BoJ’s viewpoint, this new commitment should be the highlight of today’s decision. We have argued for a stronger forward guidance measures in the past. However, in our view, such forward guidance measures is no longer effective in the current environment where the chances of the BoJ ever achieving the 2% inflation target is suspect.

So what should the BoJ have done? 

We have a certain sympathy for the BoJ. In our view, the BoJ has done its upmost to reflate the economy in the past 3.5 years. While we do think that governor Kuroda’s use of BoJ balancesheet was inefficient, there is no denying that the monetary policy in the past 3.5 years helped Japan grow and reflate itself, to some extent. However, unfortunately, it was not enough and the Japanese economy seems to be returning to its former low growth, low inflation state. What more could the BoJ do?

In our view, the BoJ has nearly exhausted its easing tools, as we analyzed in our previous piece, Time for Damage Control. The BoJ still have a few more policy tools it could use, such as deeper negative interest rates, or increasing its risk asset purchases, but the side effects of these measures are large, perhaps too large to warrant their uses in the current circumstance. In our view, the BoJ has two paths going forward. The first path is to become passive. Admit that the monetary policy alone cannot reflate the economy and encourage Japanese government to implement structural reforms from a sideline. The other path is to remain active in its effort to reflate the economy. But how? In our view, the combination of fiscal and monetary policy tools is worth exploring, if the BoJ decides to chose the active path. It does have to be "helicopter money". There should be a middle ground between the present situation and the extreme form of fiscal/monetary policy, i.e., helicopter money. Perhaps the BoJ should approach the government to reach an accord where the BoJ would play a larger role in supporting its fiscal policy, while keeping it disciplined and purposed by setting a certain condition in return for its cooperation. By the look of today’s decision, the BoJ may have edged toward taking the passive path.  But we do think it is in the nature of the governor to remain active. We will see if the decision the BoJ took today is a deceive path back to its traditional passive stance, or a pause before taking another radical, although risky, path toward resurrecting its zeal for reflation.