A new approach to monetary easing in Japan? Not yet

The Japanese economy is deteriorating and the inflation target looks out of reach.

Inflation is falling back into negative territory and core CPI has decreased to 0.6%, a long way from the 2% target. Looking at household and corporate expectations, the situation there is also deteriorating. Confidence indicators have worsened and capex might well deteriorate, as machine orders have decreased rapidly. The recent appreciation of the Japanese yen is one of the reasons for this, as it will impact corporate profits in the coming months.

Shinzo Abe, relieved at winning the Upper House election, now has full legitimacy to act and re-launch his “three arrows”. PM Abe has already announced that he will move towards significant fiscal easing. The stimulus package could be around 10 Trillion Yen, which is equivalent to 2% of GDP. It could take the form not only of incentives to encourage people out of labor force to return to work, but also of infrastructure developments and support to small and medium-sized enterprises.

These fiscal measures should be coordinated with monetary policy. The BoJ is expected to implement an additional, 3-pronged set of easing meaures, based on: quantitative easing, qualitative easing and interest-rate easing. First, it will probably buy even more bonds and ETFs, extend maturities and cut its reference rate by an additional 10bp. Only the timing remains uncertain, as the BoJ could act in July, when cutting GDP and CPI forecasts, or in the autumn, in coordination with fiscal easing.

These measures remain in line with previous easing measures. A new monetary easing approach is increasingly mentioned: “helicopter money”. This consists in issuing perpetual bonds to finance spending or tax cuts and in the central bank underwriting them. However, this action is forbidden by Article 5 of the Public Finance Act. Japan is traditionally a pioneer in monetary policy innovations and could implement those types of measures if the situation deteriorates further. However, said implementation is not on the agenda for this year, for which the overarching objective remains convergence towards a surplus in public spending in 2020.

Those accommodative policies could be supportive of equities and allow the yen to weaken. The timing and size of the announcements will be key for markets’ reactions. We therefore recommend the implemention of tactical investments on Japan through option strategies.

Nadège Dufossé – Head of Asset Allocation – Candriam