Change in BOJ policy could trigger rise in BEI – Nomura

Takenobu Nakashima, Research Analyst at Nomura, notes that following a favorable outcome in the JGBi auction on 4 August, BEI rose from 0.29% at the time of the auction to 0.39% in the 10 last days of August.

Key Quotes

“From the end of August, however, BEI moved onto a downward trajectory, taking its cue from a lower July core inflation rate than the market had anticipated, and uncertainty surrounding the comprehensive review at the BOJ's September monetary policy meeting, and by mid-September BEI had fallen to around 0.28%, roughly the same level as when the August auction was held. During that period BEI in the US and Europe pegged level while crude oil prices generally trod water, indicating to us that the decline in BEI in Japan indeed stemmed from the aforementioned Japan-specific factors.

At the BOJ's policy board meeting on 20-21 September, based on the findings of its comprehensive assessment, the BOJ committed itself to an "inflation-overshooting" policy, whereby it would continue to expand the monetary base until y-y growth in CPI (excluding fresh food) exceeds 2% on a stable footing. This marks a stronger commitment to inflation on the part of the BOJ, which had previously said that it would aim to achieve, and maintain in a stable manner, its price stability target of 2%.

After the BOJ put in place its inflation target of 2% as part of QQE1 (its first quantitative and qualitative easing program), BEI rose to around 1.9% in May 2013, up from about 0.7% in January of that year, suggesting to us that the BOJ's establishment of an inflation target resulted in higher BEI.

The BOJ has attributed the recent decline in BEI to external factors, namely (1) the decline in crude oil prices; (2) weak demand following the consumption tax hike in April 2014; and (3) the slowdown in emerging markets and associated volatility in international financial markets. Given that these factors have dropped out of the picture, and that we have the QQE1 precedent of increased BOJ commitment to inflation feeding into higher BEI, we see some upside scope, albeit modest, for BEI.

That said, we regard an immediate sharp rise in BEI as an unlikely scenario, as the latest major changes particularly in the BOJ's JGB purchasing policy have made it difficult to project the outlook for nominal interest rates, and against that backdrop real interest rates (which the BOJ sees as a factor supporting higher BEI) are also likely to remain unstable. BOJ’s citing of volatility on financial markets as a reason for low BEI also suggests that whether BEI rises will hinge on how far the BOJ is able to manage monetary policy without causing market turmoil, and that this in turn will depend on the level of understanding between the BOJ and the markets, and the central bank's adeptness fine tuning its market operations.”