The week’s first of three major central bank meetings will take place in a few hours, with the decision due after the Tokyo lunch break at 0330AM BST/1030PM EDT. The BoJ may announce changes to YCC, and ETF buys, and according to reports, it may also cut its inflation forecasts.
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The Bank of Japan concludes its latest 2-day policy meeting on Tuesday (late Monday evening EDT) in what will be the most anticipated of this week’s 3 central bank announcements – alongside the Fed and the BOE – and will be more eventful than recent meetings, considering there are mixed views on what the central bank might do following numerous media reports of a possible yield curve tweaking as well as an overhaul of the BOJ’s ETF purchases.
As RanSquawk recaps, recent source articles have suggested that the BoJ will discuss potential policy changes to its Yield Curve Control framework on the basis of sustainability, not tightening, of monetary policy which could lead to an adjustment of the yield curve target – where the 10Y JGB trades – to allow a long-term natural rise. This is said to be the cause due to the central bank’s admission that it may take even longer to hit the 2% price target, and therefore would need to ensure its policy measures can be sustained, while a policy tweak could also help alleviate some of the side-effects from its prolonged ultra-loose policy which has squeezed banks’ profits.
And yet, few expect that the BOJ will make an explicit YCC determination today, as an increase in the JGB yield target appears unlikely at a time when it is expected to revise downward its inflation forecast; instead in consideration of the adverse side effects of its policy, the BoJ will likely declare at the end of its statement that, based on its analysis in its quarterly Outlook Report, that it will maintain its easing policy for an extended period but will conduct financial market operations and asset purchasing operations to address the mounting cumulative side effects.
One likely easing measure to deal with such side effects will include an overhaul of its JPY6 billion ETF purchasing operations, a shift from Nikkei 225-linked ETF to Topix-linked ETF, which would likely spur investors to follow suit in rebalancing their portfolios should this materialize.
Conversely, virtually nobody is convinced a hawkish tweak will be announced, considering that inflation remains far from the 2% target and with BoJ Governor Kuroda denying any knowledge of the aforementioned “YCC adjustment” reports. Furthermore, several BoJ watchers view the central bank as unlikely to tighten monetary policy before October, despite all the speculation, while some have even suggested further easing could be on the table to support inflation.
Considering the sharp rate steepening – both in Japan and abroad – observed ever since the first BOJ rumors were two weeks ago, any major disappointment in the BOJ announcement which precludes a YCC tweak, could see global 10Y and 30Y yields “plunge like a rock” to use a Donald Trump term. This is especially likely in the aftermath of three consecutive fixed-rate operations – the latest one this morning – in which the BOJ announced it would purchase unlimited amounts of government bonds at yields of 0.11% and 0.10%, an attempt to cap gains in long-term yields, and keep them near the 0% target, something it would not do if it intended to prepare the market for higher yields.
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The BoJ will also release its Outlook Report consisting of board members’ median forecasts for real GDP and core CPI;
From the latest Outlook Report:
- Fiscal 2018 forecast at 1.6%.
- Fiscal 2019 forecast at 0.8%.
- Fiscal 2020 forecast at 0.8%.
Core CPI
- Fiscal 2018 forecast at 1.3%.
- Fiscal 2019 forecast at 1.8% (excluding effects of sales tax hike).
- Fiscal 2020 forecast at 1.8% (excluding effects of sales tax hike).
This may be the most eventful part of the BOJ announcement, as reports have suggested that the BoJ will likely miss its inflation target for another three years, and accordingly, may reduce its inflation forecasts to around 1.0% from 1.3% for FY18 and to 1.5% from 1.8% for FY19. This follows softer than expected headline national CPI for June at 0.7% versus expectations of 0.8% (and unchanged from from May).
Sellside calls:
MUFJ Morgan Stanley expects the BoJ to maintain policy at the upcoming meeting, but states that action in the October meeting is a possibility in which the BoJ could adjust the long-term yield target to between -0.1% and +0.2%.
Goldman Sachs expects BoJ to maintain policy settings and cut core CPI forecasts, while it also sees BoJ asserting additional easing is unnecessary and that momentum in prices is being sustained. Furthermore, Goldman Sachs thinks policy adjustments would be challenging due to subdued inflation and state the BoJ are unlikely to come to a definitive conclusion in regards to policy tweaks.
Here are more details from Goldman’s Naohiko Baba:
We expect the BOJ to sharply lower its inflation outlook at the Monetary Policy Meeting (MPM) on July 30-31, but to maintain its current monetary policy. However, we note that several media outlets (Reuters, July 20; Jiji, July 20) have reported that the BOJ will debate adjustments to its monetary easing policy at this MPM. Our base case remains that the BOJ will defer any decision on concrete measures for future discussion, but we do not rule out the possibility of the BOJ making some form of adjustments at the upcoming MPM.
And while few expect the BOJ to make any major, actionable decisions, here is Goldman’s menu of the six possible options before the BOJ:
1. Raising short- and long-term (10-year) interest rate targets
Interest rate targets are directly linked to the 2% inflation target. Accordingly, if the BOJ raised its interest rate targets at the same time as it sharply cut its inflation outlook, the markets would likely view such action as signaling that the BOJ had effectively abandoned its inflation target and started to search for an exit. This would likely give rise to considerable upward pressure on the yen and would therefore be difficult to implement, in our view.
2. Shortening the long-term interest rate target term
Another option would be to shorten the long-term interest rate target term to 5 years, for example, from the current 10 years. As with option (1), however, this would probably be viewed by the markets as the BOJ looking for a premature exit. In addition, it could result in a large rise in interest rates looking at the overall yield curve and would therefore be difficult to implement out of concerns about yen appreciation, in our view.
3. Widening the tolerable band from its 10-year yield target
With this option, the BOJ could keep its 10-year yield target, but widen the tolerable band somewhat from around the present ±10 bp. In our view, this is the most likely option given the difficulty of options (1) and (2) in terms of the consistency with the 2% inflation target. By emphasizing that it was prepared to tolerate a larger movement either way (up or down), the BOJ would send a neutral message regarding its interest rate target. In this case, the BOJ would only tweak its policy statement without specifying any particular new range, and the new degree of tolerance would likely be shown in unlimited fixed-rate operations. According to our FX strategist team, even a small tweak like this could be seen by market participants as the first step in an ongoing adjustment, rather than a one-time measure, and as a result, the USD/JPY could strengthen to ¥108 (or possibly ¥105 if risk sentiment worsened; click here ).
4. Removing the guideline for JGB purchases (¥80 tn a year)
The net increase in BOJ JGB purchases in the past year was just over ¥40 tn, meaning the guideline of ¥80 tn per year has already become a guideline in name only. As such this would likely be the option of least resistance for the BOJ under normal circumstances. That said, an issue could emerge with respect to how to assuage potential concerns of reflationist Policy Board members (Deputy Governor Masazumi Wakatabe, Yutaka Harada, and Goushi Kataoka). If the BOJ were to place priority on preventing complications in discussions, and sought the cooperation of the reflationist camp, it could conceivably opt to keep its ¥80 tn/year guideline, while acknowledging that it has already lost substance.
5. Reducing its ETF purchase guideline (¥6 tn/year)
Equity markets are a little unstable at present, partly due to concerns about trade friction, and thus announcing a reduction of ETF purchases at this juncture could potentially trigger a correction in share prices. We assume the BOJ and the government would prefer to avoid this scenario, especially in the lead-up to the Liberal Democratic Party’s leadership selection on September 20-21. Therefore, the likelihood of the BOJ reducing its ETF purchase guideline is quite low, in our view.
6. Changing the composition of the ETF purchase program
Reducing Nikkei 225-linked ETF purchases and increasing TOPIX-linked purchases while maintaining the annual ETF purchase guideline is a realistic option, in our view. However, this would merely be the default route given it has already been done once before, in October 2016.
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