‘Don’t fight the Fed’ was the cry from the market during successive rounds of US quantitative easing, neatly summing up the market’s frothy reaction to announcements of increasing bond purchases over the past few years.
But ‘Don’t anger Abe’ is the new phrase of the day after the Bank of Japan surprised markets at the end of October by announcing an extension to its qualitative and quantitative easing programme.
The BoJ will now purchase ¥80 trillion (£436bn) in bonds each year as it strives towards its 2 per cent inflation target – an increase of ¥10 trillion to ¥20 trillion (£54bn to £108bn) on the old QQE measures. This is a serious and much-needed push towards the inflation target after April’s consumption tax increase, and an economy that plunged by just over 7 per cent on an annualised basis in the second quarter of the year. Parallels were quickly drawn with the 1997 consumption tax hike, which plunged the economy back into recession. Advocates of ‘Abenomics’ were quick to exclaim that ‘This time it’s different.’
The argument goes that back in 1997 the catalyst for the country’s decline was the start of the Asian financial crisis, not the higher tax rate. And it is different this time: retail sales were better than expected in September, as were the industrial production numbers. However, wages – which are critical to driving domestic demand – are rising, but not fast enough, and consumer confidence nose-dived in September. More importantly, when stripping out the impact of the higher tax rate, inflation is running below 1 per cent. While this is a vast improvement, it is still far from the BoJ’s ideal.
The BoJ is quickly expanding the size of its balance sheet to drive the economy, force down the value of the yen, and generate inflation. Assuming the bank increases the size of its balance sheet by ¥80 trillion in the next year, then the balance will be over ¥350 trillion (£1.9 trillion) – an increase from the current 47 per cent of GDP to a massive 72 per cent of GDP. This will ultimately lower the value of the yen, increasing the cost of imports, thereby causing inflation and providing a boost to exporting companies.
But some of the other nuanced parts of the BoJ’s announcement should not be overlooked for their market impact and investment implications. The bank said that it would triple the annual purchase of exchange-traded funds to ¥3 trillion (£16.4bn) and that ETFs which track the JPX-Nikkei 400 Index would be eligible. This relatively new index, according to the factsheet, “is composed of companies with high appeal for investors”, which could be interpreted as companies with a higher return on equity.
We have already seen moves by the Japanese government to improve corporate governance in order to boost the value being returned to shareholders. Selecting the JPX-Nikkei 400 Index is another such move. Companies not in the index may be incentivised to raise their return on equity by increasing earnings, dividend payments or share buybacks. The Government Pension Investment Fund (GPIF), the giant fund that manages the Japanese people’s pension money, is also planning to include companies in the JPX-Nikkei among its domestic equity allocation.