Tricks of performance

BoJ governor Haruhiko Kuroda announced the introduction of a “yield level target” for 10-year government bond yields at about 0 per cent. The aim is to steepen the yield curve, which will be welcomed by Japanese banks and insurers.

The Japanese central bank decided against increasing its annual asset purchase target of Yen 80trn (£136bn). However, the BoJ did reiterate its willingness to overshoot its 2 per cent inflation target, allowing it to continue to expand the amount of money in the economy, and send a message to investors that it is not giving up on its 2 per cent inflation goal despite the annual inflation rate standing at -0.5 per cent.

The many elements of the announcement should have little immediate effect on the currency. Since last Wednesday, we have seen the Japanese yen trading in a range against the US dollar. Further yen strengthening is more probable than weakening.

The decision to aim for a 0 per cent rate for 10-year Japanese Government Bonds (JGBs) shows the central bank is keen to reassert the “zero lower bound” at longer maturities and, in effect, preserve the steepness in the yield curve. Making the yield curve steeper (longer-dated bonds more expensive than shorter-dated ones) is crucial for the profitability of Japanese financial institutions, who borrow at short-term rates and lend at the long-term rate. The steeper the curve, the more the bank can pick up in interest charges to the end borrower.

But many economists are sceptical that monetary policy packages like these can work, particularly in a country where economic growth has been hard to come by.

It is not clear that the BoJ can pull this rabbit out of the hat, because the central bank’s hands are tied on two fronts: first, the effectiveness of stimulating consumer and corporate spending, and second, the effectiveness of policy tools. JP Morgan Asset Management expects that the financial markets and the public will get a peek behind the curtain, realising the extent of these policy limitations and thus making the positive impact of further easing short lived.

Japan’s unemployment rate declined to 3.0 per cent this summer – its lowest level since May 1995. The BoJ calculates the country’s structural employment rate to be around the low-threes, which means the country is close to full employment. So getting even more people working and subsequently consuming more is going to be hard to do. Most importantly, the BoJ estimates the gap between potential and current growth is close to zero. This means, no matter what the BoJ does, the added benefits from solely monetary easing are limited.

As for monetary policy measures, the BoJ’s supply of things to buy may be running out. Government bond and equity purchases so far have resulted in the BoJ owning 40 per cent of the JGB market and become a top-10 shareholder in more than 90 per cent of Japanese-based companies.

Given this scepticism, the spotlight is now shining on fiscal policy. On 2 August, prime minister Shinzo Abe and his cabinet officially approved another fiscal spending package, which amounts to more than Yen 28trn.

This makes it the third largest fiscal stimulus in the country’s history, next to the packages announced in December 2008 and April 2009. However, out of that Yen 28trn, the amount to be spent by the general government is Yen 7.5trn, while the rest will be spent by private enterprises, with incentives. Meanwhile, estimates suggest that the total impact on real GDP is only about 1.3 per cent, and this will be spread over this fiscal year and the next.

For now, I am watching each monthly data point to see if the BoJ has been able to work its magic, or if this is one conjuring act that has passed its sell-by date. 

Nandini Ramakrishnan is a global market strategist of JP Morgan Asset Management