When he began his first term in 2013, he pledged to reverse two decades of stagnant prices by raising the rate of inflation to 2% in just two years. Five years on the underlying inflation rate remains stuck at 0.5% despite a massive BOJ asset purchase scheme that has swollen the central bank’s balance sheet to almost 100% of Japan’s GDP.
Exhibit 1: Despite the BOJ’s large-scale asset purchase scheme, inflation has barely risen (Japan consumer price index, year-on-year change in %)
Source: Datastream, BNP Paribas Asset Management, as of 16/04/2018
Despite his failure to raise inflation, Mr Kuroda was appointed for a second term after his first spell at the helm of the central bank saw solid economic growth, a fall in the unemployment rate to 2.4% and a doubling of stock market prices.
Kuroda policy: inflation targeting and yield curve control
Inflation is an issue that could put the governor’s credibility at stake. The whole point of quantitative easing through asset purchases was to drive inflation to 2%. The BOJ continues to believe that wages will eventually start to rise and that this will feed through into higher prices.
Since September 2016, the BOJ has aimed to hold 10-year bond yields at around zero percent, but there has regularly been market speculation about the prospect of policy tightening. A briefing Governor Kuroda gave to the Japanese Parliament last week was interpreted by some as raising the prospects of a tweak in yield curve control.
In our view, even if Kuroda does not wait until inflation rises all the way to 2%, he needs to see inflation a little higher before he can actually tweak policy. We think the threshold is 1% or higher for CPI ex-energy. Earlier this year, we expected this level to be achievable, possibly in the next 12 months, as a tighter labour market led to higher wages.
However, the yen’s recent appreciation (see Exhibit 2) is threatening to put paid to this scenario. The higher yen brings disinflationary pressure via lower import prices. It also hurts the earnings of exporters, which is negative for the outlook for wages. But if Mr Kuroda cannot tweak his policy in the near future, there’s a risk that prolonged negative interest rates will damage Japan’s financial sector.
Exhibit 2: The yen’s recent appreciation threatens to nip any rise Japanese inflation in the bud (USD/JPY)
Source: Bloomberg, BNP Paribas Asset Management, as of 16/04/2018
A potential spanner in the works: political risk
The other risk for Kuroda is political. If Prime Minister Abe fails to repair the damage various scandals have done to his administration, it could mean the end of Abenomics. The latest controversy relates to activity logs for the army dating back to its deployment during the Iraq war (a particularly sensitive subject in Japan given the strict constraints on the army under Japan’s constitution).
A second scandal (over the sale of public land) refuses to go away, with claims that Japan’s Finance Ministry tried to cover it up. The third scandal, where a friend of Abe might have received a “special favour” in opening a college, is also heating up.
Abe’s approval rating is sinking: the latest data suggest that, for the first time in six months, Abe’s cabinet enjoys the support of only a minority of Japanese voters. But Abe’s fall could be a blessing in disguise for Kuroda. In our view, Fumio Kishida, the frontrunner to be the next prime minister, is already showing some understanding for the BOJ’s policy tweak.
And of course Japan is not immune to what happens further afield. A global downturn would probably put paid to any hope of Japanese inflation reaching 2% in the medium term (i.e. by 2021/22).
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