DEUTSCHE BANK: The BOJ is unlikely to follow in the ECB's footsteps

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Next Friday the Bank of Japan (BOJ) will conclude its latest monetary policy meeting, an event that coincides with the one year anniversary of the bank expanding its monetary policy stimulus program — known as QQE — from 60 to 70 trillion yen per annum to its current level of 80 trillion per annum.

The timing of the event, along with news overnight that the ECB will likely expand its monetary policy easing program when it meets in December, has seen expectations for the BOJ to follow suit flourish in recent weeks.

While markets, like they were before the ECB’s meeting overnight, are evenly split on whether the Bank of Japan will further expand its QQE program, Michael Spencer, chief economist at Deutsche Bank, believes the BOJ will stand pat on this occasion, suggesting that tight labour market conditions and recent readings on traditional core inflation — that which excludes price movements in energy and food — may see the BOJ forgo the opportunity to ease policy further at this meeting.

Spencer admits that while there are similarities between when the BOJ eased policy in October last year and what is currently transpiring today — the Japanese economy is likely in recession, just as it was a year ago, while stock markets have been volatile, as was the case in the lead up to last year’s October policy meeting — there remain some stark differences.

“Perhaps the biggest difference in the backdrop to the BoJ meeting is in the oil market. Indeed, the more than 20% drop in oil prices in two months prior to last year’s end-October meeting may have been the determining factor leading to the decision to augment QQE. In contrast, oil prices have been reasonably stable over the past two months,” he wrote in a research note released overnight.

With oil prices broadly steady, albeit at still-low levels, and labour market conditions tightening, Spencer believes there has been a clear improvement in wage and inflation trends in recent months.

“The BoJ can point to a clear improvement in wages and inflation compared with a year ago,” he wrote.

“While headline and core inflation are weighed down by falling fuel and transportation costs, ‘core-core’ inflation – the more conventional ex-food and energy measure of core inflation – has risen to an 18-month high of 0.8% yoy, doubling in just three months. Seasonally adjusted, core-core CPI has risen at an annualized monthly rate averaging 2% over the past three months. The 3m/3m annualized rate of change of core-core inflation is the highest in more than a decade.”

The charts below tell the story. The so-called “core-core” inflation rate, used by most major central banks globally when it comes to policy setting, along with wages growth, are both moving in an upward trajectory.

With wages growth currently running at a decade high and inflation readings steadily improving, Spencer suggests that the grounds for the BOJ expanding their QQE program aren’t in place at present.

“Putting together the evidence, we think the BoJ will view with some concern the dip in businesses’ output price expectations, although this will likely be counterbalanced by those same firms’ views that the labour market is exceptionally tight. Consumer price data suggest that price-setting behavior may have changed markedly in recent months in a way that could reinforce the trend towards rising inflation. With the energy price imposing only a transitory downward bias to inflation and underlying inflation showing upward pressure, we think the BoJ will hold off on any further easing for now and wait to see what transpires in the spring round of wage negotiations.”

The BOJ will announce their monetary policy decision on October 30. The bank introduced QQE in April 2013 to achieve the price stability target of 2% in terms of the year-on-year rate of change in the CPI rate. On its website the bank states that it will continue with QQE as long as it is necessary for maintaining the CPI target in a stable manner.

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