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News | Question of the Week, WC 6th August
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Question of the Week, WC 6th August

Q: In light of the July meeting, any ideas on where the BoJ is ultimately trying to head now?

A: The Bank published a lot on decision day in July. Overall, I think they are switching to damage control. The Analysis on Wages and Prices really amounts to a slow burn erosion of the 2% inflation target, setting out why it has proved so illusive. Some of the factors suggest that inflation merely is taking longer to respond that they though. That means they have to make the policy less distortionary in the meantime. Others imply that the target simply is too high. In particular, when they talk about productivity and  technological change, this suggests that 2% is out of reach. They even present some of the analysis as “new”, implying that they weren’t aware of this when the 2% target was set. 

Even where the BoJ is convinced that inflationary forces are working, they think it will take time for it to head higher, and time is running out this cycle. Even with strong wage inflation, many of the barriers to CPI inflation remain. In the outlook, they say that capacity will continue to tighten this year, and remain substantially tight next year, i.e. not tightening. They also talk about potential growth increasing modestly and downside risks to GDP growth next year due to peaking Olympics-related demand and the Capex cycle anyway waning. So they are rightly concerned that inflationary pressure could soon start to moderate. I’d add slowing Chinese growth this year and the end of the U.S. in late 2019 or 2020 to their list of worries that GDP growth is peaking out.  But in the meantime, their policy is raising the risk of financial disarray

They could respond by going for bust, but given that Governor Kuroda has just started his second term, and Deputy Governor Amamiya appears to be in it for the long-run, they run the risk of having to pick up the pieces. In the context of the Fed continuing to hike rates, I’d say that widening the band around the 10-year JGB target will amount to a hike. I think the policy will operate similarly to China’s interest rate corridor and their RMB management. They’ll intervene if rates rise too rapidly but they’ll allow the 10-year yield to go to the 20bp ceiling. If pressure is maintained along the ceiling, I think they’ll hike the target. News reports since the July meeting have increased our conviction that the Bank will hike rates this year.

In short, I think that yesterday’s move was a baby step toward minimising the build-up of financial distortions. It wasn’t substantial enough to make a difference, but I think that is the direction they are going in. Much more detail in the Monitors.

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Posted: 9th Aug 2018

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