At the September policy meeting, the Bank of Japan made significant dovish changes to its policy framework. Japanese stocks rose as the commitment to keep the 10-year around zero allows the BoJ to control the slope of the yield curve and safeguard banks’ profitability. But, the Yen initially appreciated before stabilizing as the market appeared to interpret the new policy framework as a way to taper bond purchases.
In our view, the BoJ has doubled down. (see here)
First, the BoJ has set in place a framework for cutting the policy rate further into negative territory, reducing the costs for banks from such a policy with a bull steepening of the yield curve.
Second, to establish the credibility of the new framework, the BoJ will continue to expand the monetary base at around the current pace. To keep both the quantity and the yield commitment, the BoJ can buy more short-dated bonds than 10-year or longer-dated JGBs, leading to a wider interest rate differential between JPY and US short-term rates. This will push USD/JPY higher.
Third, gradually moving away from monetary targets will enhance the durability of the programme by eliminating concerns about scarcity of JGBs.
Fourth, the BoJ has removed any market pressure on the government to finance fiscal deficits: any increase in public spending or cuts in taxes can be financed by issuing JGBs at a zero or lower rate and the BoJ’s balance sheet can potentially expand by even more than JPY80trn per year. Although the BoJ has disappointed by not cutting the policy rate at the September meeting, we think its actions demonstrate a willingness to innovate with its monetary policy measures and a commitment to its inflation target. This continued policy divergence versus the US should continue to drive the JPY weaker against the USD.
FX Forecasts: Our USD/JPY forecasts at 108, 110 and 115.
Monetary Policy Forecast: The BoJ has committed to very accommodative monetary policy until the price stability target of 2% is exceeded sustainably. We expect the BoJ to continue to ease policy by further interest rate cuts. FX interventions are less likely.
Things to Watch: We are watching for any signs that the economy is responding to ongoing monetary easing and to evidence that the new policy framework is not about tapering JGBs purchases.
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