Japan: Bank of Japan Takes a Breather

Overview: Bank of Japan (BoJ) as expected left its leading interest rate unchanged at 0.1% at today's monetary meeting in a unanimous decision. The range of eligible collateral for lending at BoJ was expanded slightly, how-ever this was only a minor move compared to the non-conventional easing measures announced at previous monetary meetings. Pressure on BoJ to introduce new quantitative easing measures is moderating. First, the government will soon announce a new fiscal stimulus package covering the new fiscal year and BoJ might choose to wait for a clearer view on fiscal policy before it decides on new quantitative easing measures. Second, there have recently been some signs of stabilisation in manufacturing activity both abroad and in Japan. They have been accompanied by a recovery in stock prices and a weaker JPY and hence pressure on banks' capitali-sation and exporters' competitiveness is easing.

Hence, the coming BoJ meetings will probably prove less dramatic than the recent ones. At the next meeting BoJ will probably revise its GDP forecast significantly down and it might announce final plans to purchase banks' subordinated debt. However, BoJ is unlikely to step up quantitative easing significantly in the coming months, particularly its purchase of government bonds.

Details

• Despite the bad March Tankan released last week there has been no major change in BoJ's view of the economy. BoJ's main view remains that economic conditions have deteriorated significantly and are likely to continue deteriorating for the time being. BoJ does see a ray of light however, as it now believes that the decline in exports and industrial production will moderate as inventory adjustments progress. BoJ's main scenario is that the Japanese economy will start to recover in the second half of this fiscal year (ending March 2010) but it believes that risks to this scenario are mainly on the downside.
• Only modest new quantitative easing measures were announced. It was decided to expand the range of eligible collateral to include loans on deeds to the governments, loans guaranteed by the government and loans on deeds to municipalities. It is believed that smaller regional banks in particular will benefit from these measures. BoJ's main quantitative easing measures currently include purchase of com-mercial papers, purchase of corporate bonds with maturities less than one year, purchase of stocks from financial institutions, provision of liquidity for banks on longer maturities (up to three months) and a significant expansion in eligible collateral. BoJ is still considering purchasing subordinated debt from banks. A final decision on purchase of subordinated debt might be announced at the next monetary meeting on 30 April.

Impact: Overall today's announcement should be viewed as slightly negative for longer-term bond yields as it appears unlikely that BoJ will announce additional new major quantitative easing measures in the coming months and apparently does not regard the recent increase in long-term bond yields as a major problem. The impact on JPY is unambiguous. Aggressive quantitative easing measures will probably not be a major driver of further JPY weakness. However, improving risk sentiment and the weak Japanese economy will continue to weigh on JPY.

Danske Bank
http://www.danskebank.com/danskeresearch

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