July 29 2016, 15:00 JST, 2016

BoJ to consider a new policy framework

Observing the initial negative market reaction after the BoJ decision, we can almost hear the cry of despair from inside the BoJ building. “If that was not enough, what more could we do?” In our view, doubling the ETF purchase to 6 trillion yen per year is a significant, even reckless measure. The BoJ already owns close to 9 trillion-yen worth of equity ETF. By the end of 2017, the BoJ’s exposure to equity market will grow to 17 trillion yen. If the equity market is to face a severe downturn, it would wipe-out the capital of the BoJ. While the government could supplement the capital shortfall, such event will expose the peril of QQE to the wider public and force the central bank to end the QQE prematurely. It is a nightmare scenario for policy makers.

A legislative capital flight will not be out of the question

In our view, the BoJ has nearly exhausted its means of easing. While there are measures it could take, such as lowering the policy rate further into negative territory, or steps leading to helicopter money, the risks that they entail does not seem to evoke any benefit which the Japanese economy could gain from them. The calculation may change once Japan faces more explicit and severe downside risks, but, the BoJ seems to have reached the end of their easing cycle through which the BoJ pledged to raise the inflation rate to 2% in the proceeding 2 years. For more details on our view on the course of Japan’s monetary policy, please see here.

In this sense, the last sentences of the policy statement are probably an indication that the BoJ is considering abandoning its current inflation targeting framework. 

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

As we wrote here, the BoJ had already effectively changed its inflation framework as early as in September last year, but failed to disclose the change to the market. It is high time the BoJ should correct its miscommunication.