The question to be asked after today's Bank of Japan decision is whether we are heading for a race to the bottom in currencies. The BoJ admitted that the currency is a factor in deciding monetary policy and that they will closely monitor the impact of the strong yen. But can a weaker currency be a by-product of QE or part of the policy itself.
For Japan, this scenario is a stretch. Japan was already expanding its balance sheet well before other central banks joined the fray in late 2008 and early 2009. If we take the change in the central bank balance sheet from mid-2008 to mid-2012 as a proxy for stimulatory measures, the increase in the Bank of Japan's balance sheet has been modest in comparison to its international counterparts. The increase in the BoJ balance sheet represents 7% of GDP, which is around half that of the UK and the ECB over the same period.
Both the UK and eurozone saw their currencies depreciate over this period, but around 11% and 16% using a basket of currencies, whereas the yen has increased nearly 50% during the same period. Now, we can't ascribe these differences just to the change in central bank balance sheets seen over this time. There are a host of other factors at play over this time. Furthermore, on the same basis, the dollar has risen around 14% during this period on a 12% increase in the Fed balance sheet (compared to mid-2012 GDP).
There are two further points to bear in mind before we think about currency conclusions. Firstly, Japan comfortably represents the fact that it's the change in the central bank balance sheet that matters more, rather than the size. The BoJ's balance sheet is still the largest of the major central banks, representing over 30% of the economy. Secondly, Japan remains the world's strongest creditor nation, so holding far more in overseas assets than foreigners hold of their assets and this ensures a strong and on-going demand for yen from interest and dividend repatriation flows.
But what remains key and is likely to frustrate the Japanese authorities is that the Fed has left its latest QE program open ended, promising to buy securities month after month until the economy shows sufficient improvement (but leaving the definition of this open-ended). The dollar reaction was telling, falling even further after the announcement and this coming after declines in the previous 3 weeks.
This has shown that currencies are becoming more sensitive to renewed quantitative easing measures, but although the BoJ move was not fully anticipated, the Fed has played a stronger hand, which is going to continue to add downward pressure to USD/JPY.