BoJ leaves policy unchanged but won't hesitate to ease

Emily Nicol

While US stocks ended yesterday slightly lower, Asian equities largely posted gains today as markets awaited news from the resumption of the China-US trade negotiations. While the BoJ predictably left monetary policy unchanged at its meeting today, the Policy Board appeared to strengthen its commitment to ease policy further if required. And so, despite a particularly disappointing Japanese industrial production report, the Topix closed the day ½% higher. China’s main CSI 300 was also up 0.4%, as was South Korea’s Kospi, although this failed to fully reverse yesterday’s losses.

The yen initially fell back towards ¥109/$ following the BoJ’s broadly dovish stance, while 10Y JGB yields were little changed at -0.16%. Gilts opened a little higher as concerns about the prospects of a no-deal Brexit continued to rise, which saw sterling decline to its lowest level against the dollar for more than two years, while it was closing in on 1.09/€ for the first time since September 2017. And after the first estimate of French Q2 GDP saw growth moderate to 0.2%Q/Q, the mood in European markets seems unlikely to improve significantly today as the European Commission’s economic survey is expected to signal a further notable deterioration in business conditions at the start of Q3.

The conclusion of the BoJ’s policy-setting meeting today predictably provided no amendments to its main monetary policy framework, with the Policy Board maintaining a ‘wait and see’ stance. In particular, the yield curve control parameters were unchanged, with the marginal interest rate on excess bank reserves at -0.1% and the commitment to purchase JGBs so that 10Y yields will remain around zero percent also maintained. The BoJ again pledged to conduct its JGB purchases in “a flexible manner” so that its holdings will rise at an annual pace of about ¥80trn, notwithstanding that actual purchases have tracked well below that level over recent years - the BoJ’s JGB holdings increased by ¥58trn in 2017, by ¥38trn in 2018 and are currently on track to increase by just ¥20trn in 2019.

But while it maintained the wording on its forward guidance that the current extremely low levels of short- and long-term interest rates will be maintained “for an extended period of time, at least through spring 2020”, the BoJ appeared to strengthen its commitment to further easing if required, noting that it would not hesitate to take additional easing measures if greater downside risks to achieving its price stability target materialise - a point that Kuroda was keen to re-emphasise in his post-meeting press conference.

While the Policy Board optimistically maintained that Japan’s economy is likely to continue on an expanding trend through FY21, the BoJ again nudged down its GDP growth forecast for FY19 by 0.1ppt to 0.7%Y/Y, while the median growth forecast for FY20 was unchanged at 0.9%Y/Y and lowered by 0.1ppt in FY21 to 1.1%Y/Y. Although given the downside risks to domestic demand from the impending consumption tax hike and increased risks to the global outlook too, these growth forecasts still look too strong to us.

Board members were also slightly more downbeat about the inflation outlook. The median forecast for core inflation (i.e. CPI less fresh food) was lowered by 0.1ppt in FY19 and FY20 alike to 1.0%Y/Y and 1.3%Y/Y respectively. But with the output gap judged to remain positive, the BoJ continues to expect some further improvement in FY21, with its forecast unrevised at 1.6%Y/Y. Of course, this means that core CPI will remain persistently sub-target across the forecast horizon. Moreover, the BoJ admits that the risks to both the growth and inflation outlooks are skewed to the downside.

The challenging environment facing Japanese manufacturers was again highlighted in today's IP release. Certainly, June’s production figures came in much weaker than expected, with the 3.6%M/M decline the steepest since the start of 2018. And this left output more than 4% lower compared with a year earlier. While the weakness was broad based, production of transport equipment declined a whopping 7.9%M/M, with autos output down more than 9%M/M, while production in the notoriously volatile ICT equipment sub-sector fell more 10½%M/M. As such, the drop in production of consumer durables was particularly striking, with the near-9%M/M drop the steepest for more than two years. Output of consumer non-durables (-1.3%M/M), capital (-5.8%M/M) and investment (-5.0%M/M) goods was also weaker too.

Admittedly, the weakness in June was to some extent payback for strength seen earlier in the quarter. As so, over the second quarter as a whole, manufacturing output rose 0.6%Q/Q, albeit reversing only a fraction of the 2½%Q/Q contraction in Q1. While the METI maintained its usual optimism about the near-term production outlook – forecasting a rise of 2.7%M/M in July and 0.6%M/M in August – a further pickup in inventories to their highest level since February 2009 and a notable drop in shipments last month suggests that manufacturers might well scale back production further over coming months.

The latest labour market figures were more mixed. On the positive side, the number of people employed increased for the first month in three in June, to 67mn, an increase of more than 600k over the past year. As such, the unemployment rate edged lower by 0.1ppt to 2.3%, matching the 26-year low reached in February. But the near-term outlook remains more uncertain. While still signalling a very tight labour market – which the BoJ still hopes will push wages and inflation higher in due course – the job-to-applicant ratio fell for the second successive month in June, by 0.1pt to 1.61, a twelve-month low. This principally reflected a further decline in the number of job offers, down for the fifth month out of the past six to its lowest level since October 2017.

Euro area:
Following last week’s seriously disappointing business sentiment surveys (including the flash PMIs and German ifo), the principal focus in the euro area today will be the Commission’s business and consumer surveys – which arguably provide the best guide to GDP growth in the euro area – for July, for further insight into economic conditions at the start of the third quarter. But while the flash consumer confidence indicator unexpectedly improved in July (rising 0.6pt to -6.6), business conditions are likely to have further deteriorated, causing the headline ESI to decline to a more-than three-year low.

In terms of economic growth in Q2, this morning’s first estimate of French GDP aligned with our expectations (although fell short of the market consensus), with growth moderating 0.1ppt to 0.2%Q/Q, its softest pace for a year, to leave output up 1.4% compared with a year earlier. Household consumption was also softer in Q2, with growth of 0.2%Q/Q half the pace seen in Q1. But this contrasted with a pickup in government consumption (up 0.3ppt to 0.4%Q/Q) and private sector investment growth (up 0.4ppt to 0.9%Q/Q). And overall, final domestic demand accelerated slightly in Q2, contributing 0.4ppt to GDP growth. So, with net trade providing a negligible contribution, growth was principally dragged lower by private sector inventories which provided a negative contribution of 0.2ppt, having boost GDP by 0.3ppt in Q1.

Meanwhile, ahead of tomorrow’s flash euro area CPI estimate for July, this afternoon will also bring preliminary German inflation figures for the same month. Having surprised to the upside in June, the headline EU harmonised CPI rate is expected to have eased 0.1ppt to 1.6%Y/Y. In the markets, Germany will sell 10Y bonds.

As the Fed’s two-day FOMC meeting gets underway today, the principal data focus will be on the monthly spending and income figures for June, including the closely watched deflators. Strong jobs growth in June should lead to firm income growth, while spending on non-durables was also likely firmer. And we might also see an above-average reading on the core PCE index. This afternoon will also bring the Conference Board’s consumer confidence survey for July, along with pending home sales figures for June and the S&P Corelogic house price index for May.

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