With Abe’s new government having recently announced a bumper boost of ¥10.3trn (more than 2% of GDP) to central government spending over coming quarters, attention in Japan is now firmly on the BoJ, whose Policy Board meets tomorrow for the first time this year, to see whether it will also do its bit to hotwire the stalled economy. And, at face value, the BoJ looks set to deliver, with a strengthening of its commitment to tackle deflation likely to be accompanied by another round of monetary easing. Indeed, less than a year since it announced an inflation ‘goal of 1% for the time being’, the BoJ looks set to adopt a medium-term inflation ‘target’ of 2%. However, having last year already stated that its medium- to long-term goal for CPI was 2% or lower, the devil of the new commitment will very much be in the detail, not least in terms of how it suggests that future policy decisions will be linked to the inflation outlook.
Since last February, the BoJ has repeatedly pledged to continue easing ‘until it judges that the 1% goal is in sight’, and also committed to maintaining its asset purchases through 2013. So, an important test will be the extent to which those commitments will be strengthened. Reports suggest that the BoJ will discuss whether to announce that its asset purchase programme will be open-ended. But while a pledge to open-ended purchases until the 2% target is in sight, or even achieved, would clearly mark a significant strengthening of its commitment in the fight against deflation, it also seems unlikely. More likely – at least for as long as Shirakawa is Governor – would be a pledge to continue easing until ‘1% inflation has been achieved’ or ‘until 2% inflation on a sustainable basis is in sight’ and a willingness to extend its purchases into 2014 if necessary.
Even without the amendment to the BoJ’s monetary targets, the economic backdrop arguably provides sufficient justification for more monetary easing. For example, the BoJ’s latest regional report, published last week, highlighted the main headwinds that faced Japan's recovery at the end of 2012. Strikingly, the BoJ downgraded its economic assessment in eight out of Japan’s nine regions for the second successive quarter, with most assessed to be ‘weakening somewhat’ or to have ‘been relatively weak’. And this weakness was attributed principally to declining manufacturing production against the backdrop of subdued external demand. So, while recent yen depreciation – of almost ¥10/$ since the BoJ last published its projections – will in due course provide some relief, we still anticipate that the BoJ will need to revise down its expectation of GDP growth in the present fiscal year from its forecast of 1.5% published three months ago. The weaker yen should, however, give credence to the Bank’s previous growth forecast of 1.6% in FY13, although the fiscal stimulus arguably justifies an upward revision to 2% or more.
Notwithstanding the more positive growth outlook, spare capacity – not least related to the fragile labour market – will maintain deflationary pressure for some time to come. And with the BoJ’s preferred core measure of CPI inflation (excluding prices of fresh foods) expected to have slipped further into negative territory at the end of 2012 – December’s data are due for release on Friday – it looks inevitable that the BoJ will continue to forecast deflation for the current fiscal year as a whole. But further ahead, the inflation outlook looks set to be subject to modest upside pressures, not least from the recent yen depreciation. This was highlighted by the latest corporate goods price data, which showed that the headline rate rose to an eight-month high of -0.6%Y/Y in December, with import price inflation (on a yen basis) up almost 3½%Y/Y. In addition, with the oil price around 25% higher (in yen terms) than its level when the forecasts were last compiled, we could well see the BoJ revise up its expected inflation profile over the remainder of the forecast horizon.
Nevertheless, excluding the direct impact from the proposed increases in the consumption tax – which will act to sap demand in FY14 and FY15 – underlying core inflation is still highly unlikely to reach 2% for the foreseeable future. So, given its likely stronger stated commitment to ending deflation, and for fear of disappointing the market and politicians alike, we expect the BoJ to deliver another round of easing at tomorrow’s meeting, increasing its purchases of short-dated JGBs and T-bills by ¥5trn a piece, taking the asset purchase target for the end of 2013 to ¥86trn. Whether such further incremental easing will have a notable impact on the outlook for growth and inflation, however, is highly questionable. Indeed, with the government’s nominations for the next Governor and Deputy Governors to be made in February, despite the new policy pledge due tomorrow, we might well have to wait for the new BoJ leadership to be in place to bring a more effective step-change in the BoJ’s strategy.
Chris Scicluna, Head of Economic Research
Emily Nicol, Economist