Don’t hold your breath for Japanese inflation

Japan desperately needs inflation to kick in but plans by the Bank of Japan to push inflation above its 2% target are unlikely to succeed argues Lukas Daalder, chief investment officer at Robeco Investment Solutions in his latest note.

After watching the effects of QE and negative savings rates fail to stimulate growth in the domestic economy, The BoJ wants to push 10-year government bond yields to zero, but Daalder says that there are five key factors which are likely to see its latest plans fail also.

First among these factors is that the signals the BoJ wants to send to the Japanese economy and investors is likely to be misunderstood. Lower yields suggest lower costs of financing, which ought to stimulate investment: but recent years have seen lower yields associated with signals that the economy is weakening.

Secondly, with so many ageing people in Japan, lower bond yields are more likely to lead to more savings rather than more spending in the economy.

Low to negative yields are encouraging people towards paper money, which suggests the central bank is “losing grip on the money supply,” Daalder says.

Deliberately targeting the yield curve with monetary policy is leading to normal market pricing mechanisms being shut down, causing pricing distortions that can lead investors to take on too much risk; the incentive to accumulate debt remains.

Finally, the new policy is likely to have a negative impact on banks and their profitability.

Meanwhile, the lack of inflation continues to haunt Japan.

“Looking at the track record, inflation may have temporarily been boosted above 2% back in 2014, but this was solely a result of the consumption tax increase administered back then: underlying inflation has never managed to reach the target,” Daalder says.

“In fact, despite the very aggressive QE programmes introduced since then, core and headline inflation have once again moved towards deflation territory in recent months. Having structurally missed the target for more than three years – in fact, for over 20 years already – it sounds a bit strange that you then raise that target.”

“The reason for this change appears to be rather academic: having studied why inflation has failed to pick up despite the huge monetary stimulus, the researchers of the BoJ concluded that this was mainly due to too-low and stable inflation expectations. By explicity lifting the 2% target, the BoJ apparently is hoping to change something in the underlying structure.”

“Whether companies and households will be very impressed by this change in policy, after having been confronted with low-to-no inflation for over 20 years, is somethign you can seriously questino. Higher inflation expectations come with higher inflation, not because a central bank is raising its target.”

Having lost its export-led growth to China through the 1990s while simultaenously rejecting immigration as a way to rejuvinate consumption, what Japan has been left with is yen manipulation. But for this to succeed it needs to be blended with structural reform and higher wages in order to properly stimulate inflation, Daalder argues.




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