Japan economy gets the shock treatment
BoJ takes a radically different approach to beating the slump, writes Ambrose Evans-Pritchard.
The Bank of Japan has launched the most daring monetary experiment of modern times, aiming to double the money base within two years to overpower deflation and catapult the economy out of a slump. The blast of money is expected to reignite the yen "carry trade" and flood global markets with up to $US2 trillion ($1.9 trillion) of pent-up savings, giving the entire world a shot in the arm.
The BoJ's new team under governor Haruhiko Kuroda voted 8 to 1 for a double dose of "quantitative and qualitative monetary easing", vowing to inject stimulus for "as long as it takes" to break the deflation psychology. "This will be recorded in economic history books as a watershed in central bank action. Investors should be shocked and awed," Stephen Jen, of SLJ Macro Partners, said.
The monetary base will rocket from 29 per cent to 56 per cent of gross domestic product by next year. The pace of bond purchases will rise to 7.5 trillion yen ($74.3 billion) a month, almost three times the US Federal Reserve's stimulus as a share of the economy. The maturities will stretch to 40 years, ending the three-year cap that has hobbled policy for a decade.
"This is a huge sum. It could set off a rip-roaring economic boom if they buy the bonds from insurance companies and boost broad money by 10 per cent over the next year," Tim Congdon, from International Monetary Research, said.
Kuroda said the bank had taken "all available steps" to meet its new target of 2 per cent inflation within two years. "This is an unprecedented degree of monetary easing," he said.
The scale of action caught markets off guard, sending 10-year bond yields tumbling to a record low of 0.44 per cent. The yen weakened three "big numbers" to 96 yen against the US dollar, in the biggest one-day move for more than a year. The Australian dollar broke parity and on Friday was trading at 100.9 yen. The Nikkei index of stocks jumped 2.2 per cent, crowning a 50 per cent rise since October.
Hans Redeker, from Morgan Stanley, said the package was dramatic enough to break "Endaka" - the strong yen - once and for all. "The carry trade is going into full swing. Japan's institutional funds are going to wind down their currency hedges from 70 per cent to a normal hedge ratio nearer 35 per cent, and that will free up $1 trillion of overseas lending," he said.
"This is a gigantic fixed-income machine. They don't buy equities and real estate. They buy bonds, and we think they'll look at peripheral eurozone markets like Italy and Spain."
Japan's legendary housewives and grannies - so-called "Mrs Watanabe" - lead a phalanx of retail investors with another trillion dollars waiting to venture abroad once again in search of yield. In the 2003-08 cycle, the money leaked into everything from Australian "Uridashi" bonds and Icelandic debt, to London property.
Simon Derrick, from BNY Mellon, said Japan's battle-weary investors may be more cautious this time, chilled by North Korean jitters and tensions with China. "We don't think the climate is yet right for the carry trade," he said.
Hiroaki Muto, from Sumitomo Mitsui, said the Kuroda experiment could go badly wrong if markets started to think the BoJ was printing money to cover Japan's fiscal deficits.
Japan is the only major country yet to start retrenchment. Premier Shinzo Abe is boosting spending by an extra 2 per cent of GDP to kickstart recovery, though the budget deficit is already 9 per cent.
Japan has had no trouble raising funds from its captive debt markets so far, but ageing costs are rising and public debt will reach 245 per cent of GDP this year. The International Monetary Fund says Japan may hit the buffers unless it changes course soon, warning that confidence can evaporate fast. A 200 basis point rise in borrowing costs would play havoc with public finances.
Kuroda played down the concerns, insisting there was no risk of a "sudden" jump in long-term rates or a fresh asset price bubble.
Japanese officials say monetary stimulus should protect against a debt compound trap by cutting "real" rates. While Japan's borrowing costs look low, they are higher than in the US, Britain or Germany if adjusted for deflation.
The Kuroda policy is radically different from past episodes of BoJ stimulus, mostly half-hearted tinkering to fend off political pressure. It brings the BoJ into line with the US, Britain and Swiss central banks.
The European Central Bank looks increasingly isolated after it sat on its hands on Thursday, offering little to soften the credit crunch in Italy and Spain. The hawkish stance is leading to an over-valued euro. "We're afraid that the euro could rise further. That is the last thing that Europe needs," Redeker said.
The euro has risen 32 per cent against the yen since July, giving Japanese exporters an edge over European rivals. A Ford executive warned last month that Japanese car makers were poised to sweep the EU market.
An army of doubters question whether Kuroda's shock therapy will feed through to the real economy. Daragh Maher, from HSBC, fears a "damp squib" outcome that exposes the limits of central banking, or a "UK replay" where inflation rises but wages lag, causing a squeeze in real incomes. "Neither would point to a new era for Japan's economy."