Goldman Sachs thinks the Bank of Japan framework will largely be left unchanged
At its MPM next week (September 20-21), the BoJ will present the results of the "comprehensive assessment" of its current policy framework with the view of achieving its 2% price stability target as soon as possible. At the crux of this assessment will be discussion on the transmission mechanism of the policy effects and the possible factors that have hampered this mechanism given that the central bank has failed to achieve its 2% price stability target despite adopting unprecedentedly large-scale monetary easing. Though the central bank achieved initial success in lifting inflation and hence inflation expectations, the pick-up in inflation has failed to be sustained. While the BoJ has pointed to external factors (weakness in emerging markets, lower oil prices ) for this weakness, the tightening in financial conditions this year would have also negatively impacted activity and price trends.
We provide our take on what to expect from the BoJ next week and the implications for the JGB curve. In line with our Japan Economics team, we think that the BoJ will keep its policy framework unchanged, though will likely try to incorporate some flexibility around its JGB purchases, particularly in the 25+ year sector. However, we push back against the idea that the BoJ will explicitly try to engineer a steeper yield curve to address the issue of profitability of financial institutions. With a low and uncertain path for inflation expectations, any increase in nominal yields will translate into a jump in real rates which would be counter-productive. The risk of mis-communication or mis-interpretation of any shifts in JGB purchases would increase market expectations of an impending tapering and could impair the central bank's pursuit of its price stability target
We believe that while the BoJ will appreciate some flexibility in its framework in managing purchases at the long end of the curve and could also provide guidance on rate cuts later in the year to lower front end-rates, it would guard against giving any signal that would lead to a significant move higher in yields. With current inflation trends extremely weak and with Gov. Kuroda acknowledging only a gradual expected increase in inflation expectations (and with considerable uncertainty), the rise in nominal yields would only increase real rates, which would be completely counter to what the QQE's transmission mechanism is about. The increase in real rates could put the JPY under an increasing appreciation pressure as the wall of capital that left the shores of Japan on account of portfolio rebalancing comes back to capture the 'engineered' increase in rates.
We think that the BoJ would refrain from any explicit 'curve shape-targeting' message in its comprehensive assessment owing to the risk of an overshoot in nominal yields in the wake of subdued inflation expectations and its resulting FCI tightening consequences. The BoJ's and Gov. Kuroda's ability to coherently and comprehensively communicate the results of this assessment as well as the direction of future policy will be crucial in ensuring that the BoJ's commitment towards its price stability target is not lost in translation.
For bank trade ideas, check out eFX Plus .