- Bank of Japan – Some Further Thoughts
As we have had more time to digest the announcements from the Bank of Japan (BoJ) last Wednesday, there are a number of things that catch our attention. Firstly, my old university economics professor used to teach me that “you can control the price of something, or you can control the quantity of something, but you cannot control both the price and the quantity of something”. Yet that appears to be exactly what the BoJ are trying to do. Announcing a move to Yield Curve Control, the BoJ are targeting a rate of around 0% on the 10-year Japanese Government Bond (JGB), whilst simultaneously maintaining the annual pace of JGB purchases at the current run rate of JY80trn per year. The pledge to keep the 10-year JGB rate around 0% may involve bond purchases being less or more than they have been so far – less if the 10-year JGB continually trades below 0%, more if it continually trades higher than 0%. So there’s an inherent inconsistency in both these targets. Maybe, as ex-U.S. Federal Reserve Chairman Ben Bernanke suggested, the BoJ was concerned that dropping the JY80trn yearly purchase target would lead market participants to think that the BoJ was “tapering” its Quantitative & Qualitative Easing programme.
Secondly, the BoJ announced that they would aim to overshoot the inflation target of 2%. But how credible is that aim when Japanese inflation has averaged just 0.6% since 1985, and the current rate is -0.4%? Perhaps this aim is being formally adopted to quell those constant rumours that the BoJ were going to abandon their 2% inflation target – it would be very hard to ditch the target now. But the bigger question relates to whether this signals the end of QE as a central bank policy tool, and whether central banks are implicitly acknowledging the ineffectiveness of QE programmes as they are currently designed.
- Could the ECB follow the Bank of Japan’s Actions?
Talking about the end of QE, the European Central Bank’s (ECB) decision earlier this month to postpone a decision on the extension of their QE programme had people speculating as to what might happen when the ECB eventually taper their own bond-buying activities. Then the BoJ’s move from quantity-based purchases to price-based purchases naturally got investors wondering if the ECB might follow the BoJ’s lead. After all, the BoJ has been leading the way with unconventional monetary policy actions and there has been much chat over the last 2 years as to whether Europe is facing the same problems as Japan – the “Japanification” of Europe as the Head of our European investment-grade fixed income team, Tanguy Le Saout, calls it. Like Japan, Europe faces low growth, no inflationary pressures, a problem with a scarcity of assets for its central bank to buy and a Banking sector that is being affected by a negative deposit rate. However, that’s where the similarity ends.
Firstly, the ECB would face enormous logistical issues if it moved to price targeting rather than quantity-targeting in its QE programme. How would the ECB set a yield target across the different Eurozone yield curves? And even if they could manage to agree and set a target for all curves, the constant movement in spread differentials would mean that the ECB, by necessity, would be moving away from capital key-based buying. I’m sure the Bundesbank would have something to say about that. Secondly, the ECB has acted to offset the detrimental effects of negative rates on banks’ profits by offering long-term funding at negative rates via the Targeted Long-Term Rate Operations. Thirdly, the scarcity issue is arguably less of a problem for the ECB at the moment. Only if the ECB’s QE programme gets extended will scarcity issues really come to the fore, and these could be relatively easily addressed by changes to the current rules of the QE programme. Fourthly, a price-targeting policy would be likely to attract some serious legal challenges from those who feel that the ECB is overstepping its constitutional rights. Finally, we expect that Euro-area inflation will slowly recover over the course of the next two years, although probably still not reaching the ECB’s target of “close to, but below 2%”. In our opinion, it’s too early to suggest that the ECB will follow the BoJ’s actions.