Japan starts playing the liquidity game, says MLWM’s Johan Jooste

Johan Jooste, chief market strategist EMEA at Merrill Lynch Wealth Management, says that the latest moves by the Bank of Japan underline its commitment to do away with deflation.

Last week, the Bank of Japan (BoJ) surprised the markets by announcing a “massive” and significant new monetary policy easing that finally compares to the likes of that undertaken by the Federal Reserve and Bank of England.

While the two year target for a 2% inflation rate is optimistic in our view, it underlines the BoJ’s commitment to rid the nation of deflation. It may also pave the way for additional monetary policy easing if required. The BoJ policy actions are likely to have a visible impact through this year and next on markets outside of Japan too, especially EM Asia. While investors are understandably worried that a potential headwind to EM Asia is a stronger U.S. dollar (as the Fed eventually begins to arrest its asset purchases), we are less concerned, due to a combination of more positive factors outlined below.

For his first meeting last week as the new Governor of the BoJ, Haruhiko Kuroda beat already high expectations, unveiling an ambitious “quantitative and qualitative monetary easing” policy framework qualified as “massive” in the statement released. The BoJ’s objective, to re-inflate the economy to a 2% inflation target, is to be achieved within two years. Though we believe such a short timeframe is optimistic, it highlights the commitment of the new BoJ leadership. Among the measures revealed to reach its objective, the BoJ will almost double the size of its balance sheet to ¥270 trillion by the end of 2014. The maturity of the assets purchased has also been extended to include forty year Japanese government bonds (JGBs), moving the average duration of JGBs purchased from around 3 to 7 years. Like the Fed, the BoJ believe that lowering long-term interest rates provides the best environment to stimulate corporate investment.

On the economic side, the market is likely to monitor closely how the new monetary policy framework will influence both households’ and companies’ inflation expectations. BofA Merrill Lynch Japan Economics team believe that even if households only shift a few percent of their JPY1,500 trillion of financial assets into investment trusts, this factor coupled with yen depreciation and rising stock prices should give a further boost to inflation. This step would be essential, as persistent deflation has been deterring consumer credit growth and private sector spending over the last decade. Persistently higher inflations expectations, however, ultimately need to result in sustained wage growth, in our view.

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