No BoJ rate cut, but new policies brought in to boost inflation

The Bank of Japan (BoJ) did not cut rates but did introduce two new policy measures at today’s meeting.

The first is “QQE (quantitative and qualitative easing) with yield curve control” which essentially means directing asset purchases so as to keep 10-year government bond yields close to zero. When combined with changes in the policy rate at the short end this should enable the BoJ to control the yield curve. The second is an “inflation overshooting commitment” which means keeping monetary policy loose until inflation exceeds 2% and stays above target.

Some relief for banks
The first measure aims to mitigate the adverse effects of negative interest rates on the financial sector, a policy which squeezes bank margins. By targeting a zero 10-year JGB (Japanese government bond) yield, the BoJ can at least ensure that the curve is positively sloped with a negative policy rate, thus helping the banks (which essentially borrow short and lend long). The financial sector led a strong rally in the equity market in response.

Raising inflation expectations is key
The second measure is an acknowledgement by the BoJ that they have failed to hit their 2% inflation target. Increasing the target to one of “overshooting” may seem perverse, but the aim is to raise inflation expectations in the economy. Increasing the commitment to higher prices is a bold attempt to break the deflationary mind-set which holds back wage rises and thus reinforces low inflation.

Further action likely to be needed
Today’s moves have been well received by the markets: alongside the rally in the equity market, government bond yields have risen slightly and despite an increase in volatility the yen has been stable. There was a risk that by not cutting rates the market would have seen today’s action as hawkish, thus sparking a strong rally in the yen and a tightening of financial conditions. However, in terms of economic impact we are sceptical as to whether today’s moves will make much difference. The overshooting commitment is welcome, but for it to succeed the public must believe that the BoJ can credibly raise inflation, something it has failed to do so far. That does not mean it will fail, only that more action will be needed and we would look for a rate cut at the next BoJ meeting on 1 November.

Keith Wade – Chief Economist & Strategist – Schroders