Konnichiwa, forex friends!
The BOJ finally announced the results of its “comprehensive assessment” as well as a new policy framework that caused the yen to tussle a bit.
And here are the major takeaways that you need to know about.
1. BOJ’s “comprehensive assessment”
As promised in the previous BOJ Statement, the BOJ conducted a “comprehensive assessment” of the effectiveness of its existing frameworks, which are unimaginatively titled “Quantitative and Qualitative Monetary Easing (QQE)” and “QQE with a Negative Interest Rate.”
And in this “comprehensive assessment,” the BOJ concluded that its monetary policy frameworks were effective in pulling the Japanese economy out of the quicksand of deflation.
Heck, financial conditions and economic activity have even improved, according to the BOJ. However, the BOJ acknowledged that reaching the target inflation rate of 2% has been difficult. And the BOJ blamed this on “exogenous developments” that weighed down in inflation, namely the following:
- “the decline in oil prices”
- “the weakness in demand following the consumption tax hike in April 2014”
- “the slowdown in emerging economies and volatile global financial markets”
The BOJ also blamed Japan’s persistent inflation problem on weakening inflation expectations because expectation formation in Japan is “backward-looking.”
Oh, if you don’t understand all that mumbo-jumbo about inflation expectation and how it affects inflation, then just know that inflation expectations mainly affect how companies compensate their employees, as well as how they price their goods to a certain degree.If inflation expectations are to the downside, for example, then companies will generally avoid increasing the price of their products and they won’t be very open to giving their employees a raise. And both scenarios naturally contribute to stagnant inflation levels.
Getting back on topic, the BOJ acknowledged this persistent inflation problem and “judged it necessary to adopt measures that will raise inflation expectations in a more forceful manner.” And that’s why the BOJ introduced a new framework that also has an unimaginative title called…
2. QQE With Yield Curve Control
This new framework was built upon the two previous frameworks and has two components: (1) yield curve control and (2) inflation-overshooting commitment, which I’ll try to breakdown below.
As mentioned earlier, the BOJ thinks that inflation expectations in Japan are formed through a “backward-looking” process, which is to say that past actual inflation data are used to form inflation expectations. The BOJ wants to change this to focus on a “forward-looking mechanism” instead. And through an 8-1 majority vote, the “Inflation-Overshooting Commitment” component of its new framework was created for this very purpose.
As to what the BOJ will specifically do, the BOJ said that it “will continue expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds the price stability target of 2 percent and stays above the target in a stable manner.”
This means that the BOJ has effectively abandoned its target of increasing the monetary base by ¥80 trillion per year. The BOJ also said that “the pace of increase in the monetary base may fluctuate in the short run.” These two statements taken together appear to open the gates for further easing.
Yield Curve Control
The “yield curve control” component is just an expanded version of the previous frameworks. It, therefore, involves market operations to influence interest rates, as well as asset purchases.
- The short-term policy interest rate was maintained at -0.1%, but the BOJ threatened that it “will cut the interest rates further if judged necessary.”
- With regard to long-term interest rates (10-year JGB yields), the BOJ wants the said rates to remain at “around zero percent” for now. And the BOJ will do this by ensuring that Japanese government bond (JGB) purchases are “more or less in line with the current pace” of ¥80 trillion per year.
- The BOJ also announced that the “average remaining maturity of the Bank’s JGB purchases will be abolished.”
- New policy for controlling the yield curve through outright purchases of JGBs with yields designated by the Bank
- New policy for controlling the yield curve through fixed-rate funds-supplying operations for a period of up to 10 years
- Exchange-traded funds (ETFs) purchases will still increase annually by ¥6 trillion
- Japan real estate investment trusts (J-REITs) purchases will still increase annually by ¥90 trillion
- The commercial paper amount outstanding maintained at ¥2.2 trillion
- Corporate bonds amount outstanding maintained at ¥3.2 trillion
The bottom line? The BOJ designated a target for long-term interest rates and introduced two additional tools to help influence the yield curve. That’s it. Everything else was unchanged, including JGB purchases, even though the BOJ made a commitment to “continue expanding the monetary base” until it reaches its 2% inflation target.
3. BOJ still has some tricks up its sleeve
In a section that was blatantly labeled as “Possible options for additional easing,” the BOJ listed down the following:
- Cut the short-term policy interest rate
- Cut the target level of the long-term interest rate
- Expand asset purchases
- Accelerate the expansion of the monetary base
The main takeaway here is that the BOJ still has some ammunition left, contrary to what some economists are saying.
4. The yen’s reaction
The yen’s reaction was pretty uniform across all pairs. The yen initially strengthened because there was no rate cut, missing expectations that the BOJ will cut further.
The yen then weakened across the board after that, probably because the market took a closer look at the BOJ’s new “QQE with Yield Curve Control” framework.
However, there was no follow-through selling, and the yen even managed to claw its way back up against its peers. This may have been due to the realization that the BOJ didn’t actually ease any further.
Although it could have also been due to profit-taking ahead of the FOMC statement.