Bank of Japan ramps up QE again amid dismal outlook

The Bank of Japan (BoJ) ramped up quantitative easing (QE) again as part of efforts to support the economy. This is consistent with a dismal outlook shown by the bank’s new economic forecasts, also published today. Reflecting continued concerns around corporate funding strains, it also decided to pay 0.1% interest to financial institutions that tap its loan programme.

Do not get too excited about the “unlimited” pledge

In March the BoJ increased purchases of equities through Exchange Traded Funds (ETFs) (see Japan heads for recession despite BoJ action). It has now returned to increasing purchases of government bonds; for investors, the most familiar asset purchased within QE.

The BoJ pledged to buy an “unlimited” quantity of Japanese government bonds (JGBs) from a previous (flexible) guide of JPY80 trillion per year. While we expect JGB purchases to increase, we caution investors not to get too optimistic, given the bank was buying at a rate below a quarter of its guidance (see chart, below).

This is a consequence of yield curve control introduced in 2016, which resulted in the purchase amount of JGBs becoming a function of the 10-year JGB yield target. This target remained unchanged at "around" 0.0% (with fluctuations up to around 20 basis points) along with the short term policy rate at -0.10%.  

JGB purchases below a quarter of its guidance


Source: Refinitiv Datastream, Schroders Economics Group, 27/04/2020

The BoJ also increased other parts of the bond purchase programme raising the upper limit of the purchases of commercial paper (CP) and corporate bonds by JPY6 trillion each to a total of JPY 20 trillion combined. It is worth noting that the additional purchases are, at this stage, a short term policy measure, expiring in September.

Reflecting continued concerns around corporate funding strains, the BoJ also built on measures announced in March to provide zero interest rate loans for up to one year. Its decision to pay 0.1% interest to financial institutions that tap the loan programme, should provide an incentive to use the scheme. A widening of accepted collateral to household debt should also help take-up.

Forecasts show slow recovery and temporary deflation

Substantial downward revisions to the bank’s economic forecasts show the damage done by the current lockdown (scheduled to last until 6 May). This quarter, board members submitted a 1pp range rather than a point forecast reflecting the uncertainty about the outlook.

In the current fiscal year(FY), the BoJ now expects real GDP to contract in a range of 3-5%. Projections for FY2021 show that the BoJ expects growth to recover somewhat, but that this recovery will take time. The most optimistic outlook suggests that the level of real GDP will be 0.7% higher than FY2019 by the end of FY2021.

Conversely, the most pessimistic outlook is that level of real GDP will be 2.3% lower at the end of FY2021. While we previously had more of a “V-shaped” recovery pencilled in, we acknowledge that this is too optimistic and like the BoJ, expect that the rebound will be weaker and possibly delayed (see: Economies in free fall as hopes fade for a V-shaped recovery).

The BoJ will likely be extremely unhappy to pencil in its expectation for CPI inflation, which is expected to fall into negative territory to a range of  -0.8% to -0.4% in FY2020, albeit temporarily. While we acknowledge that the fall in energy prices will be a key driver of this, we see a risk that deflationary expectations could take longer than expected to recover.

In the accompanying press conference, Governor Kuroda played this risk down but will likely be concerned.

Fiscal policy main tool to support economy

With little ammunition, the BoJ continues to do its best to help support the economy. It will be pleased that its actions have helped to keep financial conditions easy, keep the Japanese yen from appreciating and also supported the equity market.

However, the policy change to increase QE today does not alter the immediate outlook for the Japanese economy, which we expect to contract for two consecutive quarters, following the contraction in Q4.

Ultimately, the baton has been passed to fiscal policy to help support the economy.

Finally, the outlook for deflation will likely be unsettling for Governor Kuroda and Prime Minister Abe, who will be unable to declare the end of the deflation in his term. Whether inflation expectations can recover will be crucial to the longer term outlook of the Japanese economy.