Asia/Pacific March 19, 2021 / 09:54 am UTC

BOJ Slows QE

By Mike Gallagher

Bottom line: The BOJ March meeting fine tuning to the policy framework was largely as expected, but does point to less asset purchases in the future and a slower pace of QE.This makes it unlikely that the BOJ will hit the 2% inflation target and is more consistent with a 0-1% inflation outcome – which privately the BOJ will likely accept. 

Figure 1: BOJ Net JGB Purchases (JPY bn) 

Source: Continuum Economics

Two of the key decisions at the March BOJ meeting slow BOJ asset purchases and the reserve adjustment in theory allows the option of cutting the deposit rate.

  1. Widening of 10yr band to +/-25bps.This is to allow more flexibility for the 10yr yield to move around the zero target to allow better JGB market functioning to macro cycles.Additionally, it will likely mean a slower pace of JGB purchases in 2021 and 2022, as the BOJ intervenes less frequently (see Figure 1 for our projections).The pace will likely slow to be consistent with the pace seen in 2019.The BOJ could widen the band still further in future years, with BOJ research suggesting that investment spending would not be impacted by a 50bps fluctuation band.
  2. The BOJ removed the minimum annual target of Y6trn for equity ETF purchases, which was widely expected given the strength of the equity market and distortions caused by large BOJ holdings. The BOJ can still buy ETF’s, but the pace will likely slow with the current equity market performance and the ETF buying only picking up on a major fundamental driven fall in equities. The net result will be less asset purchases.The BOJ also made a technical switch to TOPIX focused ETF’s rather than Nikkei 225. 
  3. The BOJ introduced tiered supplements above the current -0.1% deposit rate to make life easier for financial institutions with the current deposit rate or any future cut.In theory this makes a cut in the deposit rate possible if a deflation shock is seen.However, the reality is that the shock would have to be very large, both given opposition within the BOJ board to further cuts and as the BOJ did not use this option during the 2020 recession.Our central view remains for no change in the -0.1% deposit rate in the coming years. 

Overall, the impression is that the fine tuning measures will allow the BOJ to maintain asset purchases on a multi-year basis and reduce some of the adverse side effects on the JGB and equity markets. However, today’s changes reduce the chances of the BOJ hitting the 2% inflation target, which BOJ Kuroda in the press conference was not willing to acknowledge. Instead, BOJ policy action is consistent with a 0-1% inflation outcome in the coming years. The broadening rollout of vaccines in Japan will likely mean an increase in consumer services and consumption and we now forecast 2.7% growth for 2021.This should translate into a +0.4% headline and +0.4% core inflation excluding fresh food in 2022.

From a JGB standpoint this is not a precursor to the BOJ exiting QE with YCC, but rather an acceptance that the BOJ huge JGB holdings are raising sustainability questions.More flexibility could be seen in 2022 if core inflation recovers and then the 10yr yield target maybe fine-tuned by widening the band still further or perhaps increasing the 10yr JGB target from zero to 10bps. We are forecasting that 2022 net JGB purchases will slow to Y10trn and maintain that pace in 2023-24. Japanese investors want a steeper bond yield curve between 2 and 10yr to achieve some yield pick-up. We still forecast 10yr JGB yields at 0.2% by end 2021 and 0.3% by end 2022. The BOJ has also already allowed some flexibility for the 30yr, which is not targeted but can be influenced by the BOJ. The current 0.66% yield is well off the pandemic lowest levels and we can see the BOJ allowing 30yr yields to rise to 1.00% over the next 6-12 months in line with the recovery and giving life insurance companies and pension funds a reasonable yield pick-up.

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Analyst Certification
I, Mike Gallagher, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.