The Bank of Japan may take a breather on Tuesday after introducing its negative interest rate policy at the last monetary policy meeting, but the yen’s solid appreciation since then is mounting pressure on the bank to ease further.
On January 29 the BoJ unleashed its latest round of easing, introducing a negative interest rate policy that no one saw coming.
The move came amid growing concerns over China and a steady decline in inflation expectations, which the BoJ feared may impair the chances of inflation ever reaching the bank’s 2% target.
Economists see little chance that the BoJ will cut interest rates further on Tuesday, but a large majority see further easing before mid 2016.
One reason for this is the recent strength of the Japanese yen. Since the BoJ made its unexpected announcement at the end of January the yen has appreciated around 5% against the US dollar, further impeding the BoJ’s chances of achieving its inflation target and hampering Japan’s growth outlook.
“Indeed, a stronger exchange rate lowers corporate profits, particularly in the car industry where firms generate a large share of sales via their overseas subsidiaries,” economist Marcel Thieliant of Capital Economics said in a note last week. “What’s more, a stronger exchange rate implies that the recent fall in the prices of imported consumer goods will continue for longer.”
Thieliant is among the minority of economists who think the BoJ will ease policy on Tuesday, anticipating a cut in interest rates from -0.1% to -0.3% and an expansion of Qualitative and Quantitative Easing (QQE) from ¥80 trillion to ¥90 trillion.
The BoJ currently expects inflation to reach target by fiscal 2017, however, as well as the strong exchange rate, weak wage growth is likely to see that target pushed out.
Japan’s current spring wage negotiations are expected to result in a lackluster result for workers, as low headline inflation has reduced the incentive for firms to offer higher wages and the ability of workers to bargain for them.
“To be sure, the labor market has continued to tighten since last year’s negotiations. But trade unions have scaled back their wage demands in response to subdued consumer price gains over the past year, so the talks may well end up with a smaller pay hike than the 0.7% agreed upon last year,” said Thieliant.
If monetary policy were based on economic growth figures alone, the BoJ might be inclined to ease as soon as Tuesday after figures last week revealed that the economy contracted a revised 0.3% in the final quarter of 2015.
Worryingly, the contraction in activity was led by consumer spending, which plunged 0.9% over the three-month period.
Consumer spending is an important part of the BoJ’s plan to get inflation to target, with the bank hoping to create a virtuous spending cycle in which consumers make purchases today knowing that prices will be higher tomorrow, rather than the deflationary mindset in which consumers put off spending as they wait for prices to drop.
“The Japanese economy appears to have started the year weakly following the contraction at the end of last year,” Bank of Tokyo-Mitsubishi UFJ currency analyst Lee Hardman said in a note. “However, the BoJ is not expected to provide additional stimulus as early as at next week’s meeting following on so soon from their decision to implement a negative rate.”
Hardman also noted that the BoJ is likely to find it increasingly difficult to return weakness to the yen through further monetary easing.
Source: World Business press
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