Economics Japan: deciphering the BOJ

Transcription

1 Economics Japan: deciphering the BOJ DBS Group Research 23 October 2015 The key aim of the Bank of Japan s QQE program is to address deflation mindset and create inflation expectations Policymakers believe that long-term inflation expectations have started to rise, pushing up prices / wages on a sustained basis As such, the BOJ could tolerate a short-term shock from growth slowdown so long as the deterioration in output gap is deemed to be temporary But the psychological impact of QQE tends to be short-lived. Inflation expectations could fade if the negative output gap persists We expect the BOJ to stay on hold next week. But the odds of further QQE in the coming year remain 50 The call for more monetary easing is increasing, at a time when the growth outlook deteriorates and the authorities pledge to refocus on Abenomics. The yen weakened further against the dollar to break the level of 12 this morning, amid rising expectations that the Bank of Japan would expand quantitative and qualitative easing (QQE) at the upcoming meeting on 30th Oct. The weakening of the yen was also partly triggered by the plunge of the euro overnight after the European Central Bank signaled additional quantitative easing. Against this backdrop, it s worth considering the BOJ s thinking. The key aim of QQE is to create inflation expectations The BOJ launched its QQE program in Apr 2013, pledging to double the size of monetary base and to achieve the 2 inflation target in two years. In Governor Kuroda s various speeches since then, he has stressed that changing people s deflation mindset and raising inflation expectations are key for the QQE to work (1). In Oct14 when the BOJ decided to expand the QQE (from JPY 60-70trn per annual to JPY 80trn), the governor also explained it as a move to prevent a fall in inflation expectations caused by the fall in oil prices (2). More specifically, the BOJ sees two factors that determine inflation. One is the output gap. If the economy continues to grow above Chart 1: The Phillips curve in Japan CPI inflation (tax adjusted), YoY BOJ's target Output gap, of GDP Ma Tieying (65) matieying@dbs.com 1

2 Chart 2: Core-core inflation picking up YoY (tax adjusted) - - CPI Core CPI Core-core CPI - Chart 3: Base wages started to grow YoY - - Base wages Total wages -3.0 the potential rate, capacity utilization will increase, the labor market will tighten and wages and prices should rise. The other factor is inflation expectations. The BOJ s argument is that a rise in the medium- to long-term inflation expectations will influence actual wage and price behaviors. Workers will demand pay hikes if they expect the living costs to increase. Companies will also agree to raise wages, on expectations that they can hike the sales prices to absorb the wage costs. The BOJ views the cyclical inflationary force (a positive output gap) and the structural force (an increase in the medium- to long-term inflation expectations) separately. The latter has been pointed out as a key transmission channel of the QQE. According to the governor, the shape of the Phillips curve was flat in Japan as deflation expectations were deeply rooted, which means that turning the output gap positive alone won t be enough to overcome deflation. As such, the Bank wants to work directly on people s expectations and to shift the Phillips curve upward. In so doing, the BOJ hopes to bring about a 2 inflation rate even in the presence of a zero output gap (Chart 1, previous page). The BOJ is happy with the current inflation and wage trends So far, policymakers appear happy with the modest and gradual rise in inflation and wage growth that emerged after the QQE program had been in place for two years. The core-core CPI inflation (which excludes both fresh food and energy) has moved into positive territory since Sep13, and rose to 1 in Aug15 (Chart 2). Base wages (excluding bonuses and overtime pay), meanwhile, have started to rise since the beginning of this year (Chart 3). It is unclear to what extent the ongoing rise in inflation and wages is caused by cyclical factors (an improved output gap and tighter labor market), or structural ones (an increase in the medium- to long-term inflation expectations). But the BOJ thinks the latter has played an important role. As noted by Governor Kuroda in recent speeches, behind the steady improvement in the underlying inflation is that firms and households views on prices have changed, a positive feedback loop between the increase in wages and the rise in inflation is now in place (3). If the BOJ indeed believes that a rise in longer-term inflation expectations has started to exert upward pressure on prices and wages on a sustained basis, it could tolerate a short-term negative shock from GDP growth slowdown so long as the deterioration in output gap is deemed to be temporary. The risks ahead Risks remain. Inflation expectations are affected by multiple factors and the psychological impact of monetary easing tends to be short-lived. In the household sector, inflation expectations have risen significantly over the past two years, and 2

3 Chart 4: Households' inflation expectations Chart 5: Enterprises' inflation expectations 2.5 Expected inflation rate: 1-year ahead 5-year ahead 4Q14 1Q15 2Q15 3Q15 Expected inflation rate: 1-year ahead 3-year ahead 5-year ahead 4Q14 1Q15 2Q15 3Q15 remained stable in recent months. Based on the consumer confidence survey, the percentage of consumers expecting prices to go up in the next 12 months has risen to more than 80 since Apr13, and remained very high at 86 as of Sep15. Under the latest public opinion survey conducted in 3Q15, households expected inflation rate for the next five years stood at, well in line with the BOJ s inflation target levels (Chart 4). Given that public inflation expectations remain high and sticky, workers should demand higher wages going forward to prevent a decline in purchasing power. In the corporate sector, however, price expectations have started to moderate. According to the 3Q15 Tankan business survey, enterprises forecasted output prices to rise 0.7 in the next one year, a lower rate than the previous forecast of 0.9. On the longer-term basis, price expectations for the next five years also dropped slightly to 1.8 from 2.1 (Chart 5). It appears Japanese corporates have become less confident about their capabilities of raising output prices. Should such concerns continue to grow, corporates could become reluctant to raise wages. Another risk worth noting is that the output gap is deteriorating again. GDP growth has registered a negative 1.2 (QoQ saar) in 2Q15. With exports and production weighed down further by sluggish global demand, another quarter of GDP contraction in 3Q15 a technical recession has become likely (Chart 6). For now, the risk of a sharp recession appears low. Manufacturing and services PMIs have remained above 50. A government survey on manufacturers produc- Chart 6: Industrial output fell for two quarters 2010=100, sa Industrial output Services output 80 Chart 7: Business sentiment still at high levels (all industries, all enterprises) Actual -60 Mar-01 Mar-04 Mar-07 Mar-10 Mar-13 Forecast 3

4 tion plans shows that output will expand again in Oct15 (4.4 MoM). Under the Tankan survey, enterprises forecast for business conditions in the next one quarter also stands at high levels (Chart 7). If the deterioration in GDP growth and output gap proves temporary, the negative impact on employment, wages and inflation should be limited. But if the downturn were prolonged, labor market slack would increase, which could affect inflation expectations of both enterprises and households. Policies ahead The BOJ has surprised on the size and the timing of policy easing respectively in 2013 and Bold and aggressive easing measures are needed as the BOJ wants to create influential impact on people s expectations. In the immediate term, expanding the size of asset purchases under the QQE should remain the top option, if needed. Policymakers would still like to spring surprises, either in terms of the actual size of QQE expansion or the timing of announcement. Another way would be to adjust the composition of asset purchases. The BOJ mainly focuses on buying central government bonds at present. It could consider increasing the amount of risky assets to be purchased (e.g., ETFs and REITs), and incorporating new assets into the QQE program (e.g., local government bonds). For now, we think the BOJ can take a wait-and-see approach. If it thinks inflation expectations will come down due to a fading impact of QQE or a persistently negative output gap, it would not hesitate to further ease policy. We don t expect the BOJ to take action as soon as next week. But the odds of further QQE in the coming year remain 50, and perhaps a bit higher. Notes: 1) Kuroda s speeches: Quantitative and Qualitative Monetary Easing, Apr13 Quantitative and Qualitative Monetary Easing and the Financial System, May13 Japan s Economy and Monetary Policy: Toward Overcoming Deflation, Jul13 Overcoming Deflation, and Quantitative and Qualitative Monetary Easing, Sep13 Japan s Economy and Monetary Policy, Nov13 2) Ensuring Achievement of the Price Stability Target of 2 Percent, Nov14 Welcome to the 2 Percent Club, Dec14 Crude Oil Prices and Price Stability, Feb15 3) Two Years under QQE, May15 Moving Forward: Japan s Economy under Quantitative and Qualitative Monetary Easing, Aug15 Japan s Economy and Monetary Policy, Sep15 Sources: All data are sourced from CEIC, Bloomberg. Forecasts and transformations are DBS Group Research. 4

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