How Should the "Adjustment" of
Quantitative Monetary Easing be Interpreted?
December 9, 2009
The BOJ monetary adjustment policy directive accepts that the balance of current accounts may fall below target level. The short-term impact on market rates is likely to be limited.
At a monetary policy meeting on May 20, the Bank of Japan decided to leave its target balance of current account deposits, currently set at "around ¥30-35 trillion", unchanged. However, in its directive on monetary adjustment policy, the BOJ added the postscript that "If the number of bids submitted by banks in response to fund-supply operations suggests that demand for funds is extremely low, the balance may fall below this target," effectively accepting the possibility that the balance may fall below target. A motion to "lower the target balance to ¥27-32 trillion", proposed at the same meeting, was defeated by a 7:2 majority.
The addition of this postscript is a response to the fact that, as anxiety over the future of the financial system has receded, as the demand for reserve-type funds among banks has fallen, fudaware - a phenomenon where the amount of bids submitted in respect of the Bank of Japan's fund-supplying operations is lower than the amount of funds due to be supplied - has becoming a frequent occurrence, and it has become increasingly difficult to maintain the target balance.
Lowering the target balance was also possible as a methodology, but the fact remains that, the decision, taken in January 2004, to raise the target to its current range was explained as "a strengthening of monetary easing", suggesting that the BOJ was wary that a move counter to the normal policy direction would be seen as a switch to a policy of monetary stringency. This latest decision merely allows the BOJ a broader choice of methods for attaining "a plentiful supply of funds, well in excess of the amount required" within the framework of quantitative easing, without changing the effective "target level for volume", and Japan's state of "ultra" monetary easing basically remains unchanged.
As to the likely impact on the markets, it is possible that, as the motivation for the BOJ to implement "relatively long-term fund-supplying operations", which it had stepped up in a bid to overcome the growing difficulty of supplying funds recedes, pressure for a flattening of the long end of the yield curve of term interest rates will fall, and that this will encourage a rise or prevent a fall in interest rates in that section. However, rates on relatively long-term instruments, including long-term rates, are influenced to a still greater extent by economic performance and market expectations of the period for which quantitative monetary easing will be continued, and it is safe to say that their future trend depends on the direction taken by the real economy.
The figures for real GDP in the January-March quarter of 2005, released on May 17, record annualized growth on the previous quarter of 5.3%, well above expectations, but a breakdown of the figures reveals phenomena that suggest this figure should not be taken at face value, including the facts that (i) the strong consumer spending figures are partly the result of a reaction to the slump in spending due to poor weather conditions and natural disasters in the second half of 2004, (ii) exports have fallen for the first time in 13 quarters, owing mainly to the downward trend of shipments to Asia, which account for just under 50% of total exports, and (iii) the rise in inventory investment can be attributed in part to an "intentional accumulation of inventory". Moreover, as the outlook is that the Japanese economy will remain in its current "mixed condition", with some strong and some weak sectors, now advancing and now retreating, in the short term (for details, see Market Watch No. 3 "A Revised Economic Forecast for Fiscal 2005-06"), long-term interest rates are also likely to remain within the 1-1.5% range in reflection of sluggish economic performance.
The BOJ's basic line on the balance of current accounts is likely to remain "an average of ¥33 trillion" in short term but it is undeniable that the latest decision may constitute "ground leveling preparatory to a lowering of the target range".
However, although the BOJ's decision to tolerate the balance falling below target itself was predictable in view of past observations, the fact that the "qualifications" (such as requiring the balance to be kept within the target range on a monthly average basis) that were expected to come with the decision were not imposed is somewhat unexpected. Taking a cynical view, this could be interpreted as the BOJ giving itself the option of using the fact that the track record of the balance falling below target is gradually growing longer as a fait accompli to justify future "ex post facto-ratified lowering of the target range".
At a press conference after the meeting, Governor Toshihiko Fukui clearly rejected such conjecture, telling reporters, "Even if [the balance] falls below the lower limit of the target range, it will not be allowed to do so unchecked but will be brought back within the range as soon as possible", and "[The balance] will normally be around ¥30-35 trillion. Except when it temporarily falls below the lower limit, we will consequently be able to keep [the balance] within a range centering on ¥33 trillion." However, even if this is so, the fact that the BOJ did not include clear statements to this effect in its directive leaves room for doubt.
There has never been a clear consensus between the BOJ and the markets regarding the actual process by which the policy of quantitative monetary easing is to be discontinued and, as it can hardly be claimed that this latest "fine-tuning" had the prior approval of all concerned, it is fair to say that there is still a risk of a destabilization of the process by which market expectations of monetary policy are formed. If, in future, the balance of current accounts starts to fall below target more often or the economy starts to grow with unexpected vigor, it is not entirely impossible that predictions of an early discontinuation of quantitative monetary easing will emerge, against Governor Fukui's will, and that the markets will be thrown into confusion.
For more information on the content of this report, please contact: Tetsuro Okada the Japan Research Institute, Limited.