24 February 2019
Bank of Japan governor Haruhiko Kuroda has achieved some success in stoking inflation from the depths of the country's decades-long disinflation era. Photo: Reuters
Bank of Japan governor Haruhiko Kuroda has achieved some success in stoking inflation from the depths of the country's decades-long disinflation era. Photo: Reuters

BoJ chief Kuroda’s quandary

After months of speculation, Prime Minister Shinzo Abe’s cabinet has announced nominations for the Bank of Japan’s (BoJ) new leadership. Haruhiko Kuroda will retain his governorship for a second term, and Masayoshi Amamiya has been promoted from executive director to deputy governor. Masazumi Wakatabe, the more controversial appointment, will join Amamiya as deputy governor. The nominations are pending approval by the Diet, and will go into effect on March 20 for the deputy governors and April 9 for the governor.

Kuroda, now in his fourth year as head of the central bank of the world’s third largest economy, has made it his mission to stoke inflation from the depths of Japan’s decades-long disinflation era. To do so, he has resorted to unconventional tactics such as implementing negative interest rates and buying massive amounts of Japanese government bonds (JGBs) and exchange traded funds.

And he has found some success. We expect Japan’s inflation rate to accelerate to 0.9 percent year on year in 2018, the highest rate since November 2014. While the presence of inflation is notable, the central bank’s 2 percent target is still some distance away. So it’s likely that Kuroda, if he is re-appointed, will maintain the BoJ’s current policy tone in the short term to lift inflation closer to its preferred level.

But herein lies the central bank’s dilemma: As inflation rises, the BoJ will need to increase the 10-year JGB yield target from “around zero” to probably 0.2 percent. But higher JGB yields would likely send a message to investors about the coming normalization of monetary policy and therefore spur yen strength.

The latter is typically detrimental to Japan’s export-reliant economy and therefore the country’s equity market; although this relationship broke down late last year as investors focused more on the vibrant external environment than on the effects of a stronger yen.

Japan’s central bankers will therefore need to be particularly delicate, or risk inflaming inflation and its currency. The nomination of ultra-dovish candidate Masazumi Wakatabe, who is an advocate of accelerating JGB purchases to lift nominal GDP and wage growth and raising the inflation target to 3 percent, as the second deputy governor to replace Kikuo Iwata could tip the BoJ into overheating Japan’s economy. Worries over a potential shift back to easing might prompt spikes in US dollar/Japanese yen exchange rate in the near term.

But we don’t think Wakatabe’s influence will supersede Kuroda’s or Amamiya’s, both of whom are likely to steer a gradual normalization of monetary policy this year. The BoJ has already begun slowing annual purchases of JGBs; purchases fell to 58 trillion yen (US$543.06 billion) in 2017 from 80 trillion yen in 2016, and we think they will slide further in 2018 (to 45 trillion yen) and 2019 (to 35 trillion yen).

We will update our dollar/yen forecasts (currently 110 over 3, 6 and 12 months) once the appointments have been confirmed. But given the nomination result, we believe the pairing is likely to trend slightly downwards over the long term due to the combination of yen-supportive factors (i.e., rising inflation and tightening policy) and broad US dollar weakness.

So, given the likely nominations and our view of a stronger yen ahead, investors could face bounces in the dollar/yen exchange rate over the coming weeks. Also, financial stocks would be well positioned to benefit from the normalization of Japan’s interest rate curve.

– Contact us at [email protected]


Executive Director and Regional CIO Japan, UBS

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