No BoJ rate cut, but new policies brought in to boost inflation

The BoJ move is welcome, but will the public be convinced?

21 September 2016

Keith Wade

Keith Wade

Chief Economist & Strategist

The Bank of Japan (BoJ) did not cut rates but did introduce two new policy measures at today’s meeting.

  1. “QQE (quantitative and qualitative easing) with yield curve control” which essentially means directing asset purchases so as to keep 10-year government bond yields close to zero.
  2. “Inflation overshooting commitment” which means keeping monetary policy loose until inflation exceeds 2% and stays above target.

Some relief for banks

The first measure aims to mitigate the adverse effects of negative interest rates on the financial sector, a policy which puts pressure on bank margins.

By targeting a zero 10-year JGB (Japanese government bond) yield, the BoJ can at least stop the gap between banks’ borrowing costs and lending rates from narrowing further and squeezing their margins.

The financial sector led a strong rally in the equity market in response.

Raising inflation expectations is key

The second measure is an acknowledgement by the BoJ that they have failed to hit their 2% inflation target.
Increasing the target to one of “overshooting” may seem perverse, but the aim is to raise inflation expectations in the economy.

Increasing the commitment to higher prices is a bold attempt to break the deflationary mind-set which holds back wage rises and thus reinforces low inflation.

Further action likely to be needed

Today’s moves have been well received by the markets: alongside the rally in the equity market, government bond yields have risen slightly and despite an increase in volatility the yen has been stable.

There was a risk that by not cutting rates the market would have seen today’s action as hawkish, thus sparking a strong rally in the yen and a tightening of financial conditions.

However, in terms of economic impact we are sceptical as to whether today’s moves will make much difference.

The overshooting commitment is welcome, but for it to succeed the public must believe that the BoJ can credibly raise inflation, something it has failed to do so far.

That does not mean it will fail, only that more action will be needed and we would look for a rate cut at the next BoJ meeting on 1 November.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.