Flemming J. Nielsen
Danske Bank A/S
We no longer expect Bank of Japan (BoJ) to ease further in 2014. First, there just has not been enough movement in BoJ’s communication in a more dovish direction in the past month. Second, the recent sharp depreciation has also taken considerable pressure off BoJ for more easing. Third, it now appears that fiscal policy will be tightened less than expected. Fourth, there is increasing focus on the costs from BoJ’s aggressive bond purchases with particular attention on BoJ possibly destroying the liquidity in the government bond market.
In our view, it will be extremely difficult but not impossible to reach the inflation target next year. Further easing is possible in Q2 15. We see three options for additional easing. (1) The target for the monetary base could be increased by JPY10- 15trn to JPY70-85trn mainly through expansion of bond purchases. (2) A more modest increase of less than JPY5trn by increasing purchases of ETFs and REITS. (3) A 10bp cut in the interest rate on excess reserves to 0%.
Our call for a weaker JPY is not dependent on additional easing from BoJ. (1) Any additional easing will only be marginal compared with the aggressive monetary easing BoJ is already doing. (2) Public pension funds in Japan are expected to shift their portfolios towards a larger share of foreign securities. (3) The Fed will gradually start to normalise monetary policy.
On a worrying note, the Japanese government now appears to be starting to deviate significantly on its target to balance the public primary budget balance by 2020. This will probably not be a major negative for Japanese government bonds as long BoJ continues its QE programme. However, the reforms that the government is currently implementing will also make the Japanese government bond market much more vulnerable in the future.
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