For the second time in three months the Bank of Japan (BOJ) stunned financial markets last week, this time for holding monetary policy settings steady when most were expecting either an increase in asset purchases or a further reduction in interest rates, or both.
The fallout for the decision was instant, and epic.
The Japanese yen screeched higher, recording its largest one-day percentage gain in more than five years, while the Nikkei 225 — Japan’s benchmark stock market index — tumbled more than 8% in just over one session of trade.
For other central banks, it served as a timely reminder as to just how savage markets can react when lofty expectations aren’t met by policymakers.
For Robin Brooks, Silvia Ardagna and Michael Cahill, FX strategists at Goldman Sachs, the BOJ decision was a “fateful miscalculation”, doing little to dispel the notion expressed by an increasing number in financial markets that the bank is running out of so-called monetary policy bullets.
Instead of preaching patience to financial markets, Goldman’s believes that the BOJ should have “grabbed the bulls by the horns”, especially given the bank downgraded its forecasts for both economic growth and inflation in the years ahead.
“Unconventional easing is above all an expectations game, where it is necessary to shock markets again and again, until they have no reason to question a central bank’s commitment to its inflation target,” said the trio in a research note released overnight.
“Preaching patience is the opposite, telling markets they expect too much.”
The chart below, supplied by Goldman, shows the steep decline in inflation expectations, something that will do little to end Japan’s deflation mindset and, potentially, make the job of returning the nation’s medium-term inflation rate to 2% all that much harder.
Due to the BOJ’s dithering on policy, Brooks, Ardagna and Cahill believe that there is little doubt that the USD/JPY will continue to move lower in the short term until governor Kuroda “is willing to grab the bulls by the horns and confront market fears over the BoJ’s balance sheet.”
“The BoJ needs to shift the emphasis of easing back to balance sheet expansion and QQE, says the bank. “We think the BoJ needs to signal that it is not afraid to expand QQE beyond JGBs if needed by, for example, taking concrete steps to lift housing loans off banks’ balance sheets.”
“We think such a step would cause USD/JPY to rapidly move back above 120, as market fears over limits to QQE abate.”
However, with the BOJ not scheduled to meet to discuss policy until mid-June, Goldman’s remain concerned about what may eventuate in the interim, particularly when it comes to currency market intervention from the BOJ.
“Our biggest anxiety is over intervention. In our opinion, this would throw out the rule book from recent years – that monetary policy is domestically focused – and the market could respond by pushing USD/JPY down to an even greater degree,” they note.
Goldman suggests that “a lot rides on the price action in comings days”, adding “an emergency BoJ meeting may become necessary if Yen appreciation gets out of control.”