Japan Overshadowed, but Important Developments

Yen, Japanese markets, bank of japan, BOJ, stimulus, abenomics

8 May 2015

Japan and the yen seem sidelined.  Japanese markets were closed for the first half of the week during for the Golden Week holidays. The weakness of the US economy and the concurrent doubts about Fed tightening this year, coupled with the dramatic reversal of euro zone assets after strong gains in Q1 have kept traders and investors focused elsewhere.

Nevertheless, there are two important developments in Japan. First, it seems still under-appreciated what the Bank of Japan did before the Golden Week celebration. It moved its goal posts. At its last meeting, it indicated that it no longer expects its inflation target to be met "in or around" the current fiscal year.  It now says it will be met in the first half of FY 2016 (April-September 2016).  

The BOJ knows what all central bankers and investors do, and that is when oil's dramatic decline last year drops out of the year-over-year comparison, measures of inflation will rise. The BOJ targets the core rate of inflation. Unlike the US measure, Japan's calculation excludes fresh food but includes energy.  

Nevertheless, the new time frame looks ambitious. In addition, it repeats the tactical mistake of the past target. Other central banks target medium term inflation, not a 12-month or 18-month objective. The proximity and precision do not in itself boost credibility. Instead, it puts it at risk by forcing it to make unnecessary decisions. 

By moving the target date but not announcing more stimulus, the BOJ may be sending an important signal. It is looking through the recent fall in its inflation measure to zero in February before firming to 0.2% in March. The disposition of the Board of Governors, especially with the recent personnel changes means that a decision to boost asset purchases would get a more favorable hearing that the 5-4 vote last October. 

However, it seems that the bar to additional stimulus is higher than many appreciated. Reports suggest that many banks who had been looking for increased BOJ efforts by July have pushed it out to October. The bar here too is likely to be moved out rather than in. 

The second important development is the government's increasing reliance on moral suasion to fulfill Abenomics. Abe has accidentally discovered the truth behind one of the old English proverbs: You can lead a horse to water, but you can't make it drink. The policies of the Abe government has weakened the yen, lowered interest rates, and boosted corporate profits. However, the benefits have been too concentrated.