BoJ maintains ultra-accommodative policy

Chris Scicluna
Emily Nicol

BoJ maintains ultra-accommodative policy despite higher inflation forecast
The first of today’s key monetary policy announcements brought no surprises from the BoJ. Indeed, there were no changes whatsoever made to its Yield Curve Control framework, which maintained the negative policy rate (-0.1%) and 10Y JGB yield target at “around 0%”. Moreover, in marked contrast to other major central banks, the BoJ reiterated that it would not hesitate to take additional easing measures if necessary.

Not least given former PM Abe’s assassination earlier this month, it certainly seemed inappropriate to remove one of his key “three arrows” at this week’s meeting. Nevertheless, the recent increase in inflation expectations, which was matched with an upwards revision to the BoJ’s inflation forecast across the projection horizon in its updated Outlook Report, might have given Kuroda an opportunity to hint at an exit strategy before his term comes to an end next April. But inflation is still expected to fall back below target before long, and remain there over the medium term.

The BoJ revised up its median forecast for core CPI (excluding fresh foods) in FY22 by 0.4ppt to 2.3%. But that is still very low by international standards. And while its projections for FY23 and FY24 were also revised up, by 0.3ppt and 0.2ppt apiece, they remained well below target at 1.4% and 1.3% respectively. The expected fall in inflation over the coning two years principally reflects base effects from energy prices. Indeed, when excluding energy, the BoJ expects core CPI to increase gradually, from 1.3% to 1.5%Y/Y by FY24. But while the risks to that inflation outlook were judged to be skewed to the upside, those rates are still inconsistent with achievement of the BoJ’s target, reflecting not least continued sub-par wage growth, justifying the commitment to leave policy unchanged for now.

GDP forecast for FY22 revised down; downside skew to risks for coming two years too
The BoJ’s dovish attitude was also justified by a more downbeat near-term growth outlook, reflecting weaker external demand and intensification of supply-side challenges. In particular, the BoJ’s median GDP growth forecast was revised down by 0.5ppt to 2.4% in FY22, with growth then expected to slow further to 2.0% in FY23 and 1.3% in FY24. Admittedly, the rates forecast for the coming two years were a touch firmer than previously projected and above-potential. But the BoJ unsurprisingly cited extremely high uncertainty regarding the outlook, not least due to the impact of the persisting war in Ukraine, status of the pandemic domestically and overseas, and the impact of tighter monetary policy elsewhere on the global economic outlook. Indeed, in light of rising expectation of US and euro area economic recession in 2023 if not before, the BoJ’s growth forecasts look too high to us.

Given its guidance last month, we continue to expect the ECB to raise rates by just 25bps today; but risks of bigger hike can't be dismissed
The main focus today will be the ECB’s policy announcement, which will bring the first hike in interest rates since the ill-fated tightening in 2011. With the macroeconomic projections presented to the 8-9 June meeting already out of date, as inflation in Q2 of 8.0%Y/Y was 0.5ppt above the ECB’s forecast, there is arguably a case for substantive tightening at this meeting. And it was not a surprise that reports earlier this week suggested that the Governing Council is discussing the case for a hike of 50bps. However, with the Governing Council having stated last month that it “intends” to raise all of its rates by 25bps this month – a decision that the account of the meeting reported was judged by most members to be proportionate – a decision to hike by more than that could damage the credibility of its guidance in future.

Hawks likely to keep door open to a hike of 75bps in September
So, while we cannot rule out a bigger increase, we still expect the ECB to raise all rates by just 25bps, which would take the key deposit rate to -0.25%, maintaining the incongruity of negative interest rates after headline inflation reached a new series high of 8.6%Y/Y in June. The Governing Council will nevertheless continue to signal that rates are expected to rise by a larger (albeit unspecified) increment in September. And we expect ECB President Lagarde to leave the door open to a hike of 75bps that month. In light of the highly uncertain economic outlook, not least risks of a lasting interruption to the supply of natural gas from Russia, the Governing Council might say little new regarding the expected rate profile in Q4 and beyond, instead likely maintaining its current guidance that it anticipates “a gradual but sustained path of further increases in interest rates”.

Ill-timed collapse of Italian government coincides with ECB discussions of new anti-fragmentation policy tool
Of course, the ECB’s Governing Council has also been discussing plans for its anti-fragmentation policy tool, reportedly to be called the Transmission Protection Mechanism. But ongoing events in Italy provide an incentive for the hawks to try to minimise any moral hazard associated with the tool, which would allow the ECB to buy bonds of countries where spreads are judged inconsistent with fundamentals and risk impairing its monetary policy transmission mechanism. Indeed, after his failure yesterday to secure the support of a majority of members of parliament, Mario Draghi is set today to resign as Italian Prime Minister, paving the way for snap elections by October (in which the populist right-wing parties will favour their chances of winning a majority), ensuring that the government is unable to pass a budget for 2023 by year-end, and also delaying disbursement of the next slug of EU recovery funds. So, the Governing Council might decide that now is not the time to reach agreement on its new policy instrument.

Any agreement on a new policy tool likely to have safeguards against moral hazard
If they do agree the Transmission Protection Mechanism, the criteria for triggering its activation are likely to be left constructively ambiguous. In addition, while bond purchases conducted under the policy might theoretically be unlimited in size, the hawks will want policy conditionality attached to the use of the new mechanism to be relatively meaningful, and at a minimum linked to full consistency with EU policy guidance. Conditionality seems bound, however, to be looser than that attached to the Outright Monetary Transactions (OMT) instrument, which requires an ESM programme also to be in place. Finally, the Governing Council should also agree how the liquidity impact of any asset purchases conducted under the policy tool will be neutralized. In this respect, we expect the ECB to offer a higher interest rate on term deposits, determined at auction, rather than sell bonds of other countries from its portfolio.

Japan’s goods trade deficit biggest since 2014, with net trade likely a drag on Q2 GDP
Data-wise, today’s Japanese goods trade numbers certainly illustrated the downside risks to the country’s near-term economic outlook. While there was a solid increase in the value of exports (4.0%M/M) in June – the most for seven months – the value of imports rose (3.6%M/M) to a new record high, to leave the adjusted trade deficit widening to ¥1.93trn, a series high. Compared with a year earlier, the value of exports was up 19.4%Y/Y, with exports to China (8.3%Y/Y) rising for the first month in four as Covid restrictions relaxed, while exports to the US rose 15.7%Y/Y and the EU by 22.1%Y/Y. Meanwhile, the value of imports rose 46.1%Y/Y.

The increased value of exports principally reflects price effects – indeed, in volumes terms, total exports fell 1.4%Y/Y, while import volumes were up just 1.3%Y/Y. When also adjusting for seasonal effects, the BoJ’s measure of export volumes rose 0.9%M/M. But given the marked weakness at the start of the quarter, this left exports down more than 3%Q/Q in Q2, the largest quarterly drop for two years. And with import volumes down around 1%M/M but up but 1.1%Q/Q, today’s release suggests a notable drag from net trade on GDP growth last quarter.

UK government debt interest payments hit record in June as inflation creates massive bill on linkers
For a change, UK net public borrowing (excluding public sector banks) came in a touch below expectations in June, at £22.9bn, £1.1bn below the median forecast on the Bloomberg survey albeit still £0.6bn above the OBR’s forecast. The figure was the second highest for any June, up £4.1bn from a year earlier and £15.6bn above the level in that month of 2019 ahead of the pandemic.

Compared with a year earlier, central government receipts were up £7.9bn, in part due to the government’s hike in National Insurance Contributions. But strikingly, central government current expenditure was up £9.0bn from a year earlier, with lower pandemic-related spending more than offset by an extra £10.3bn of debt interest payments, which reached £19.4bn in total, the highest on the series dating back to 1997. An eye-watering £16.7bn of that cost related directly to accrued interest on inflation-linked Gilts, which account for about 25% of the government’s outstanding debt stock. Payments are linked to the RPI measure, which rose in June to 11.8%Y/Y, almost 2½ppts above the CPI measure, and which is set to rise further in the autumn not least as household energy bills rise again. So, the government’s debt interest bill seems highly likely to exceed the OBR’s forecast of £87.2bn for the current fiscal year.

More happily, the estimate of the deficit in May was revised down somewhat. However, cumulative net public borrowing in the first three months of the fiscal year reached £55.4bn, some £3.7bn above the OBR’s forecast albeit still £7.5bn below the amount in the same period last fiscal year. Notably, the government’s £15bn package of support for households announced in May, which will likely only in part be funded by a windfall tax on energy firms, has yet to show up meaningfully in the public borrowing data. So, added to the ugly outlook for debt interest payments, full-year borrowing in FY22 seems bound to exceed earlier projections. Nevertheless, if – as the bookies’ odds suggest – she wins the Conservative party leadership and becomes Boris Johnson’s replacement as Prime Minister, Liz Truss has committed both to reverse April’s hike in National Insurance Contributions (estimated to raise some £16bn this year) and cancel next April’s planned hike in the main rate of corporation tax., with no commensurate plans to offset the impact of borrowing through cuts in public expenditure.

US Philly Fed and Conference Board leading indices likely to flag softer momentum
In the US, alongside the weekly jobless claims figures – which will probably see initial claims remain around the highest levels since November – today will bring the latest Conference Board leading indicators for June and Philly Fed index for July. The composite leading index is expected to have fallen for the fourth consecutive month in June, weighed by negative contributions from consumer expectations, stocks prices, initial claims for unemployment insurance, and a reduced factory workweek.

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