After winning Japan’s Upper House election and establishing a two-thirds majority in the senate, the governing coalition led by Prime Minister Shinzo Abe seems to have found strong support for its “Abenomics 2.0” measures. This should allow for increased fiscal spending measures to match up with greater monetary easing, which in turn should help speed up Japan’s exit from deflation.
With fiscal stimulus, the devil’s in the details
Abe recently unveiled the government’s plans for an economic stimulus package worth JPY 28.1 trillion – 5.6 per cent of Japan’s GDP – to show support for the economy and to inflate the value of supplementary budgets. However, while the scale of the stimulus package looks good on paper, the devil is in the details. Even though the JPY 13.5 trillion in fiscal spending that was shouldered directly by the government was higher than expected, only JPY 7.5 trillion appears to be “fresh water” – and some of that may ultimately be parceled out over several years. That would not have an immediate impact on growth, especially as the timing of actual spending is uncertain.
With new fiscal stimulus measures under way, the Bank of Japan (BOJ) is feeling pressure to join the government in supporting Japan’s economy, and anticipation was rising in advance of its 28-29 July monetary policy meeting (MPM). For the markets, the issue is that economic activity remains weak and price pressures are moderating; inflation expectations even fell further recently. Additionally, a stronger yen is weighing on profits and lowering firms’ willingness to lift wages. All in all, there is a clear case to be made for more easing, and markets have been expecting swift and determined action to counter the idea that the BOJ is running out of ammunition.
A high bar for the BOJ to clear
However, the BOJ was not able to pull a rabbit out of its hat at its July meeting: It decided not to expand its overall pace of asset purchases, and not to lower its policy rate below -0.1 per cent. Yet the bank did announce plans to almost double its purchases of Japanese ETFs, to JPY 6 trillion annually, and announced that it intends to expand its dollar lending program for overseas investment, to USD 24 billion. Additionally, the BOJ will establish a new facility to lend Japanese government bonds to banks, which should cushion the drag on the banks’ profits and provide more collateral – a particularly helpful program given today's negative interest rates.
The BOJ also recently noted that when it holds its next MPM on 20-21 September, it will conduct a comprehensive assessment of the effects of its current policy. This suggests that policymakers will wait until next month to consider further policy actions, which means that uncertainty about additional easing could linger until then. Nevertheless, this pause may give the BOJ the time to assess the government’s fiscal stimulus plan. Given BOJ Governor Haruhiko Kuroda’s penchant for surprising markets, policymakers could use this time to explore other easing options that are currently not on the table.
Overall, the Bank of Japan is in a tough position: It has not used all three dimensions of its monetary policy tools (interest rates, quantity and quality), and the market is questioning the effectiveness of QQE (qualitative and quantitative easing). At the same time, standing firm and doing nothing could increase the market's doubts about the effectiveness of the BOJ’s monetary tool box.
Talk of ‘helicopter money’ could subside temporarily
Given the fading impact of standalone fiscal and monetary easing measures, the BOJ and Japan’s government should be expected to more closely coordinate their efforts in the future – especially with the central bank’s inflation goal at growing risk of slipping out of reach. With so many factors occupying the market’s attention, we believe the sometimes intense discussions about helicopter money in Japan may quiet down – at least for now. Still, if the yen were to break the critical mark of 100 JPY/USD, the BOJ may again find itself under increasing pressure to decide what additional easing it is willing to deploy long before its September meeting.
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