BOJ to Sit Tight, Wait for Inflation to Bite

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The Bank of Japan is expected to keep policy settings unchanged on Friday when the board meets for its last policy decision of the year, though some economists expect it won’t be long before weak inflation forces the central bank to loosen policy again.

Tokyo – It will come as little surprise to markets if Bank of Japan (BoJ) Governor Haruhiko Kuroda sits tight again at
tomorrow’s meeting, particularly as recent economic indicators have actually been more upbeat, but with inflation still some way off the bank’s 2% target, further policy easing seems imminent.

The BoJ is widely expected to keep Qualitative and Quantitative Easing (QQE) unchanged on Friday, with the asset-purchasing program currently pumping in around ¥80 trillion a year into Japan’s monetary system.

“With economic activity recovering and underlying inflation holding up, there is little immediate pressure on the Bank to step up the pace of easing,” Japan economist Marcel Thieliant of Capital Economics said in a note on Tuesday. “However, we still believe that price pressures will moderate before long, so the odds are still tilted towards more monetary stimulus.”

Recent data showed the economy expanding a revised 0.3% in the September quarter, improving on the initial estimate of a 0.2% contraction in activity, while another release showed core machinery orders surging 10.7% month-on-month in October.

Admittedly, the improvement in activity follows a dearth of action in the second quarter, when the economy contracted 0.3%, but is likely to be enough to keep the central bank happy with how the economy is going for now.

In fact, Kuroda may even see the lift in activity as a precursor for stronger inflation.

The BoJ has been desperately trying to boost inflation to 2% for several years now, but sharp declines in oil prices and a weak economic performance earlier this year dampened hopes of getting there any time soon.

According to official inflation figures for October, core inflation – which excludes fresh fruit and energy prices – rose 0.7%, while the equivalent measure for Tokyo was up 0.6%.

Thieliant says that while stronger inflation of late rules out policy easing in January – as Capital Economics forecast earlier – inflation is likely to moderate again in the first few months of next year.

“On balance, therefore, we still consider it more likely than not that the Bank will step up the pace of easing by next spring,” he wrote.

Yen drifts sideways

When the BoJ launched QQE in early 2013 the impact on the Japanese yen was large, with the currency weakening around 20% against the US dollar.

The weaker exchange rate gave Japan’s export sector a big boost, but in the last year the yen has largely drifted sideways, and since mid 2015 the currency has actually appreciated against the US dollar.

A big unknown for the BoJ – and most other major central banks – has been the impact the Federal Reserve’s (Fed) tightening cycle would have on the economy.

On Wednesday the Federal Open Market Committee (FOMC) decided to lift the Federal Funds Rate for the first time in close to a decade, as was widely anticipated.

Further tightening by the Fed would see the Japanese yen depreciate further against the US dollar, something Kuroda has probably been holding out for.

A depreciation of the exchange rate would not only benefit Japan’s exporters but would also help push up import prices, supporting inflation.

Whether or not Kuroda has the patience to wait for the Fed to tighten further remains to be seen, but in the short run it is likely to keep the BoJ sitting tight on policy.

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