Despite new measures, Japan’s deflation risk remains: Coface

Despite new measures, Japan’s deflation risk remains: Coface  article image

The Bank of Japan has introduced a new framework to help boost its economy.

The new framework, Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, is aimed at strengthening its two previous policy frameworks QQE and QQE with a Negative Interest Rate.

But how effective will these new measures be?

In a special briefing paper, Coface, a global leader in credit insurance and risk management, remains sceptical that the new framework will successfully lift inflation expectations.

The new framework consists of two key components:

1.     Yield curve control

The Bank of Japan (BOJ) will control both short-term and long-term interest rates.

The short-term policy interest rate, i.e. interest rate on excess reserves that financial institutions park with BOJ, is unchanged at -0.1%.

The long-term interest rate, i.e., yield of the 10-year Japanese Government Bonds (JGBs), will remain more or less at around 0%. It increased briefly exceeded zero for the first time since March, from -0.06% before the announcement of the decision. 

2.     Inflation-overshooting commitment

BOJ is committed to expanding the monetary base until the year-on-year rate of increase in the observed consumer price index (i.e., core CPI) stably exceeds its target of 2%. 

The ratio of the monetary base to nominal GDP is expected to exceed 100% in slightly over one year from the current level of 80%.

Positive reaction

In general, markets were happy with the Bank’s decision.The Japanese yen weakened against the US dollar, and the Japanese equity indices surged. The TOPIX ended higher by 2.7%, while the Nikkei 225 rose 1.9%.

At first glance, Coface says it appeared to be quite confusing why markets were happy, as the Bank neither deepened negative interest rates nor expanded them.

However, the new framework helps to address some key market (near term) concerns, it says.

“We acknowledge the effort made by BOJ, creating some more room for further monetary easing,” Coface said in its statement.

“That said, we remain quite sceptical how this new framework itself could successfully lift inflation expectations.

“BOJ has already implemented a prolonged accommodative monetary policy, but Japan’s core inflation – what BOJ is trying to overshoot its 2% price target – stood at -0.5% in July (versus -0.4% in June), the steepest drop since March 2013, the month before Kuroda launched unprecedented monetary stimulus.

“This indicates that the deflation risk remains – despite the fact that BOJ remains confident, saying that ‘the underlying trend in inflation steadily rises, accelerate toward 2%.’

“Adding to this, we also reckon that further easing would probably have diminishing marginal effects.” 

Limited impact on business investment

Coface expects the new measures will have a limited impact on corporate bonds yields and on business investment.

“Indeed, corporates would be willing to borrow for long-term investment projects, only if they see long-term growth prospects and lower deflation risks which the current monetary policy alone could do little help.

“So, the Japanese authorities should undertake bold deregulation and structural reforms to boost productivity and wage growth.

“Otherwise, the Japan’s low-growth and deflation future is likely to remain.” 

Coface’s GDP forecast for Japan this year is 0.5%, with 0.8% forecast for 2017. 

Japan has an A2 (low) country risk assessment, downgraded from A1 in March this year.


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