Morning comment: BoJ & UK politics

Chris Scicluna
Emily Nicol
Mantas Vanagas

After hitting a record high on Tuesday, Wall Street nudged lower yesterday with the S&P500, DJI and NASDAQ indices all declining 0.2%. The US dollar continued its firmer trend, however, as did the US Treasury market with the 10Y yield falling 5bps to 2.52%. That followed the move in euro area govvies after the downbeat ifo survey that saw 10Y Bund yields decline back below zero for the first time in about a fortnight. With that background, after being down modestly during the morning trade, the TOPIX eventually closed up 0.5% and the 10-year JGB yield rose about 1bp after the BoJ Policy Board meeting ended with the announcement of some tweaks and measures best viewed as prolonging existing main policy settings (and their sustainability) in light of continued slower-than-desired progress towards meeting the Bank’s inflation objective (more on this below). In contrast, a late slump saw China’s CSI 300 fall more than 2%, while in South Korea, the KOSPI fell about ½% after GDP unexpectedly contracted 0.3%Q/Q in Q1 – a sharp contrast to 0.3%Q/Q growth expected by the market and the worst result since Q408. Within the detail, manufacturing activity fell 2.4%Q/Q – an outcome that is likely to be broadly matched in Japan when the provisional national accounts are released next month. Markets were closed for the ANZAC Day holiday in both Australia and New Zealand.

As noted above the main focus in Japan today was on the outcome of the latest BoJ Policy Board meeting and the accompanying updated Outlook Report. There were no surprises from the BoJ regarding current policy settings or the Board’s economic forecasts, but the Bank did announce a couple of small tweaks and measures largely designed to sustain current policy arrangements in the face of ongoing disappointment with the degree of forward momentum evident in inflation.

The key elements of the monetary policy framework were predictably left unchanged. So once again, the Bank’s yield curve control strategy was retained by a 7-2 vote – Kataoka and Harada again dissenting – to leave the marginal interest rate on excess bank reserves unchanged at -0.1%, as well the commitment to purchase JGBs so that 10Y yields stay at around 0%. And the BoJ again pledged to conduct its JGB purchases in ‘a flexible manner’ so that its holdings will increase at an annual pace of about ¥80trn, notwithstanding the fact that actual purchases have tracked well below that level over recent years (i.e. the BoJ’s JGB holdings increased by ¥58trn in 2017 and by ¥38trn in 2018).

Likewise, again by unanimous vote, the BoJ retained its commitment to purchase ETF’s and J-REITS at an annual pace of ¥6trn and ¥90bn respectively. But while the BoJ’s total ETF holdings (¥25trn) amount to less than 7% of the TOPIX market cap, they account for roughly two-thirds of the domestic ETF market and so the BoJ stated that it will consider the introduction of an “ETF Lending Facility”, which will make it possible to temporarily lend ETFs that the Bank holds to market participants and so mitigate the impact on liquidity of the Bank’s increasing holdings in this market.

Among other tweaks to enhance the sustainability of the current monetary policy stance was the decision to expand the eligible collateral against which it will provide credit – with the Bank now accepting a minimum corporate bond rating of BBB compared with A previously – which the Bank hopes will contribute to the smooth implementation of fund-provisioning and asset purchases as well as market functioning. The BoJ also relaxed the terms and conditions of the Securities Lending Facility, including the reduction of the minimum fee rate and abolition of the upper limit on the amount of sales per issue – a move that might have contributed to the pickup in yields today. Regarding the Bank’s special liquidity facilities – the Fund-Provisioning Measure to Support Strengthening the Foundations for Economic Growth and the Fund-Provisioning Measure to Stimulate Bank Lending – the deadline for new loan disbursements has been extended by one year to 30 June 2021.

Among other news from the meeting, one headline-grabbing tweak in the policy statement concerned the Bank’s forward policy guidance. As discussed further below, on the Bank’s best estimates the attainment of the inflation target remains elusive over even the extended forecast horizon, and that forecast is subject to risks that are skewed towards less favourable outcomes. As a result, with a stated intention of “making clearer its policy stance to persistently continue with powerful monetary easing”, the Policy Board supposedly ‘strengthened’ its previous commitment to maintain the current extremely low levels of short- and long-term interest rates “for an extended period of time”, with the clarification that this should be interpreted to mean “at least through around spring 2020”. Of course, with inflation set to remain well below the 2% target for the foreseeable future, there was very little expectation for any policy tightening within the coming twelve months. And in his post-meeting press conference, Kuroda stated that, despite today’s revised forward guidance, the BoJ “wouldn’t mull a rate hike around Spring 2020 no matter what”, further raising questions about the point of inserting this date in today’s statement.

Turning to the Outlook Report, the broad description of the economy and the economic outlook was much as conveyed in the brief statement that followed the BoJ’s previous Policy Board meeting. In summary, the BoJ continued to characterise Japan's economy has being on “a moderate expanding trend, with a virtuous cycle from income to spending operating, although exports and production have been affected by the slowdown in overseas economies.” Domestically, the Bank noted that corporate profits and business sentiment have stayed at “favorable levels on the whole, albeit with some weakness observed in part”, while business fixed investment continued to be described as being “on an increasing trend”. Similarly, private consumption spending continues to be said to be “increasing moderately, albeit with fluctuations, against the background of steady improvement in the employment and income situation”.

Looking ahead, optimistically, the Bank continues to expect that Japan’s economy will continue on an expanding trend throughout the forecast horizon. While acknowledging the likelihood of some further weakness in exports and some deceleration of business investment in the near-term, given the Bank’s outlook for a gradual pick-up in overseas growth – partly due to stimulus measures – exports are expected to resume a moderate uptrend. Therefore, with domestic demand still expected to remain on an uptrend, with the output gap remaining positive and inflation expectations forecast to increase over time, the Bank continues to expect annual CPI inflation to increase toward 2% at some indeterminate date. As previously, risks to both economic activity and prices are viewed as skewed to the downside. Regarding prices, the Bank added that “momentum toward achieving the price stability target of 2 percent is maintained” – hence no additional policy easing was forthcoming today – but the Bank did note that this momentum “is not yet sufficiently firm, and thus developments in prices continue to warrant careful attention”.

As far as the Bank’s formal numerical forecasts are concerned, as necessitated by recent economic data, the median forecast submitted by Policy Board members for GDP growth in FY18 was lowered by a further 0.3ppt to 0.6%Y/Y – still 0.1ppt too optimistic in the view of our colleagues in Tokyo. Thereafter, the economy is expected to grow at rates that are marginally above the BoJ’s most recent point estimates of potential growth, but which the BoJ characterises as being at about the same pace as potential on average. The median forecast for growth in FY19 and FY20 was lowered by 0.1ppt to 0.8%Y/Y and 0.9%Y/Y respectively. The first forecast for FY21 was a typically optimistic 1.2%Y/Y. Our Tokyo team expects growth to disappoint across each of these years.

Turning to the outlook for inflation, the median forecast of Policy Board members was slightly more downbeat on average. The median forecast for the core CPI (i.e. CPI less fresh food) remained at 1.1%Y/Y in FY19 (and an unchanged 0.9%Y/Y excluding the consumption tax hike and impact of free education policies). With the output gap expected to remain in positive territory and the BoJ counting on firms changing their wage- and price-setting behaviour, the BoJ continues to expect some improvement in FY20, although the median forecast for core inflation was nudged down by 0.1ppt to 1.4%Y/Y (1.3%Y/Y excluding the consumption tax and free education policy). The first forecast for FY21 sees inflation rise further to 1.6%Y/Y. While this represents the lowest initial forecast for three years ahead since Kuroda took over as Governor in 2013 and falls short of the BoJ’s target, the BoJ admits it is subject to downside risks and it certainly looks too high to us.

Yesterday evening’s meeting of senior Conservative backbenchers took just a little pressure off the Prime Minister, with the all-important Executive of the 1922 Committee voting narrowly to maintain the rules that prevent an explicit challenge to Theresa May’s leadership of the party before December. Nevertheless, May was still humiliated once again, with the Executive demanding that she provide a clear schedule and timetable for her departure in all circumstances, whether or not her Brexit deal, or a variant thereof, is ever approved by MPs. Conservative MPs were reminded that they could still – in the usual way – signal privately their loss of confidence in the Prime Minister by writing to the Committee’s chair to demand a challenge at the earliest possible moment. And, should – as might be expected – the Conservatives perform woefully at the European Parliament elections on 23 May, the 1922 Executive might well then revise the rules to allow an imminent challenge if May doesn’t announce her intention to step down imminently.

Of course, May’s departure would then open the path to a Conservative leadership election, which could take up to eight weeks to conclude. And, as that wouldn’t necessarily make it any easier for the new PM to pass a Brexit deal in Parliament, a General Election – which would take up a further six weeks – could subsequently ensue. So, the Conservatives’ internal strife and its consequences seem likely to dominate throughout the period ahead of (and possibly beyond) the new Brexit cliff-edge of 31 October, suggesting that a further Article 50 extension beyond that date (or revocation) might well be required to avoid a disorderly no-deal scenario.

The only UK data release of note today will be the CBI Distributive Trades survey. In contrast to the official sales figures, the survey suggested that activity in the retail sector was very subdued in the first quarter, with the relevant indicator falling in March to the lowest level since October 2017. While some improvement seems likely in the April survey, we expect the overall picture for retailers to remain challenging.

Euro area:
It should be an uneventful day from the euro area with no top-tier economic data due for release. ECB Vice President De Guindos will speak publicly in New York.

In the US, the latest weekly jobless claims data are due alongside preliminary March durable goods order figures. The slowing in the manufacturing sector seen over recent months is likely to weigh on core orders, while possible cancellations of Boeing orders after the Ethiopian Air disaster pose an additional downside risk to the total figure. In the bond market, the Treasury will sell 7Y notes.


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