The Bank of Japan needs to show what it can do

Bank of Japan governor Haruhiko Kuroda (Photo by Ng Han Guan-Pool/Getty Images)

When it comes to financial market volatility surrounding central bank meetings so far in 2016, none can surpass what we’ve seen around Bank of Japan policy meetings.

It’s been wild, to say the least.

After surprising markets in late January by announcing a shock cut to official interest rates, taking them into negative territory for the first time on record, each subsequent meeting has been met with wild gyrations across financial markets, often fueled by disappointment that the BOJ has failed to meet lofty expectations of ever-more aggressive and inventive, monetary policy stimulus.

This was certainly the case when the bank last met in July with a small increase in the amount of Japanese exchange traded funds (ETFs) the bank would purchase widely lambasted by markets who, like Pavlov’s dogs, had become accustomed to expect far more.

The decision from the bank to leave policy unchanged elsewhere saw investors, understandably, question whether the BOJ had reached the limits of what further monetary policy easing could deliver.

Already ultra loose, and having brought so much demand forward in an attempt to bolster economic activity today, some saw the decision as an admission that further easing would do little for the economy.

With the disappointment from July still fresh in the minds of investors, attention is now switching to what the BOJ will do with its next policy decision on September 21.

Like clockwork, the failure of the BOJ to announce substantial easing measures in July has seen those lofty expectations simply transfer to this meeting, boosted by the announcement that the bank will also release the results of a comprehensive assessment of developments in economic activity and prices under current policies alongside the policy decision.

Most analysts think this time will be different, and are predicting the bank will announce another aggressive policy easing to help dispel fears that it has cannot deliver any further economic benefit.

Takeshi Yamaguchi, Robert Feldman and Shoki Omori, economists at Morgan Stanley MUFG Securities, certainly think that will be the case, predicting the risk is the BOJ will follow up easing at this meeting with further stimulus before the year is out.

“We expect the BOJ to strengthen both the quantitative and qualitative components in an attempt to dispel the view that it has reached the limits of what it can achieve through quantitative easing,” the trio wrote in a research note released earlier this week.

“The methods would be by increasing regular JGB/FILP bond purchases as well as introducing corporate bonds and regional/government agency bonds to the menu.”

The table below from Morgan Stanley MUFG Securities details the easing measures that the bank expects the BOJ to deliver.

While the trio expect the bank to increase the size of its annual monetary base expansion by a further 10 to 20 trillion yen ($US100-200 billion) through additional asset purchases, they don’t see the bank cutting interest rates further into negative territory given the controversy it has already created.

“We think that the BOJ, while maintaining a positive assessment of NIRP, will opt to stay at the current level of -0.1%, justifying this, for example, by arguing that NIRP is sufficiently producing the desired effects and no further cut is needed, or on the grounds of technical issues such as delays in updating computer systems of Japanese banks,” they wrote.

“The possibility of a small cut in the rate cannot be entirely ruled out. However we see it as a risk scenario with lower probability than our base scenario.”

As for the prospect of the Bank of Japan eventually running out of assets to purchase, Yamaguchi, Feldman and Omori have supplied this nifty chart that looks at the options and outstanding stock for additional asset purchases available to the bank.

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