Japan: BoJ Leaves Interest Rate Unchanged

As widely expected Bank of Japan (BoJ) left its leading interest O/N target rate unchanged at 0.5% in a unani-mous decision. In addition, BoJ left its view of the economy broadly unchanged in the Monthly Economic Report published in connection with today's monetary meeting.

Overall there have been no major changes in BoJ's view of the economy despite the recent spike in inflation, see Flash Comment - Japan: Out of deflation - we raise our inflation forecast and the surprisingly strong GDP growth in Q1 08, see Flash Comment - Japan: Strong Q1 GDP growth on improving domestic demand. That said, Shirakawa in a recent statement underlined that inflationary risk cannot be completely ignored. This mes-sage were repeated at today's press briefing where BoJ board governor, Masaaki Shirakawa, remarked that "…inflation risk is rising globally" and " …(BoJ) monitors consumer inflation expectations and companies price set-ting behaviour closely".

However, the main message continues to be that BoJ is not overly worried about the recent jump in inflation and its main concern remains a possible sharp slowdown in the Japanese economy on the back of slower global growth. Currently BoJ is more concerned about the deflationary impact from higher energy and commodity prices on domestic demand. This priority was underlined by Shirakawa's remarks at the press briefing that "…growth is clearly slowing" and "…BoJ is more focused on downside risk". Hence, compared to most European central banks, inflation is not yet regarded as a major constraint on monetary policy. Headline CPI inflation at 1.2% is still comfortably within the BOJ target range of inflation of 0%-2% and core consumer excluding food and energy is only barely positive at just 0.1% y/y. In addition we do expect headline inflation to decline below 1% during H2 08.

Implications:

BoJ maintains neutral bias in monetary policy for the foreseeable future. We do expect BoJ to hike by 25bp by mid 2009, which is broadly in line with current market expectations. However, we believe we are entering a pe-riod where Japanese economic indicators will turn significantly weaker and hence the pricing of a close to 50% probability of a rate hike before year-end might prove too aggressive. Market reaction to today's monetary meet-ing has been limited. 2Y bond yields are slightly down 2bp to 0.82%. However, this is mostly due to lower bond yields overnight in the US.

BoJ View of the Economy
May 2008

"Japan's economy is expected to grow at a slower pace for the time being and follow a moderate growth path thereafter".

"The year-on-year rate of change in consumer prices is projected to follow a positive trend due to the rise in prices of petroleum products and food products in a situation where overall supply and demand in the economy is more or less balanced".

"Due attention should continue to be paid to factors such as uncertainties regarding future devel-opments in overseas economies and global financial markets, as well as the effects of high energy and material prices".

Last major change in BOJ view (March 2008)

"Japan's economy is expected to continue expanding moderately, although the pace of growth is likely to slow for the time being".

"The year-on-year rate of change in consumer prices is projected to follow a positive trend due to the rise in prices of petroleum products and food products in the short run and the positive output gap in the longer run".

"Due attention should continue to be paid to factors such as uncertainties regarding future devel-opments in overseas economies and global financial markets".

Forecast of policy board members (April 2008)

Current Bank of Japan policy board

Toshihiko Fukui (Neutral), Toshiro Muto (Neutral) and Kazumaza Iwata (Dove) left in March 2008.

New board slightly more hawkish as Iwata was the most pronounced dove on the old BoJ policy board.

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

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