BOJ Hilkes, Market Yawns

The Bank of Japan raised the overnight call rate by 25 bp to 0.50% and the yen sold off. Expectations had been nearly evenly divided. Early in the session, Japanese media reported that BOJ Governor Fukui had proposed a rate hike. The market reacted by taking the dollar from JPY120.50 to JPY119.75. The dollar had then stabilized until the actual announcement was made, then it fell to a marginal new low before rebounding smartly as Fukui indicated further hikes would be gradual. By early in the European session, the dollar was making new highs for the day against the yen.

There is potential for additional near-term dollar gains. The initial target comes in near JPY121. A convincing break of that area will signal a retest on the JPY122.00-20, the ceiling set in late January and again earlier this month.

Ironically today’s rate hike lends support to ideas that the BOJ’s decision last month not to hike rates was politically motivated by the heavy pressure exerted by the government. Recall last month by a 6-3 vote, the BOJ kept rates on hold. It cited concern about the slow inflation and weak consumption. Generally speaking the data released since that meeting seemed to point to even lower inflation and continued weakness in consumption.

Prices

Since that January meeting, Japan has reported consumer prices. Consumer prices at the headline level were flat in December, the same reading as November, however the core rate, which excludes fresh food, slipped by 0.1% from the zero reading in Nov. The year-over-year rate was 0.3% unchanged from Nov, though the core rate slipped to 0.1% from 0.2%. The so-called core-core rate which excludes fresh food and energy prices, stood at -0.3% in Dec and -0.2% in November.

Consumer prices for the city of Tokyo are reported with a smaller lag than national figures and are often a guide for developments on the national level. In the month of January, consumer prices rose 0.1% from a year ago, slowing from the 0.3% year-over-year pace reported in Dec. Core prices were steady at 0.2%.

Another price component that had been reported was the GDP-deflator. It stood at -0.5% for the Oct-Dec 06 quarter, slightly less than the -0.7% of the previous quarter.

Consumption

There has not been much fresh consumption data reported since the BOJ’s Jan meeting. Most of the 1.1% rise in consumption reported within the Oct-Dec GDP figures was known prior to the BOJ’s Jan meeting. In fact, the data suggests that consumption finished the quarter on a weak note. Large retail sales fell 3.4%. The market had expected only a 1.9% decline after a 0.7% fall in Nov. Overall household spending in Dec fell 1.9% year-over-year compared to a 0.7% fall in Nov. The consensus called for a 1.2% decline.

One of the factors that have undermined Japanese consumption is the weak growth in wages. Since the Jan BOJ meeting, the government reported that labor cash earnings fell 0.6% from a year ago in Dec. The consensus had forecast a 0.5% increase. In November, labor cash earnings had fallen 0.2% from a year ago. Overtime pay rose 1.6% year-over-year, though the market had expected a 4.2% gain.

The fact that the BOJ raised rates in February even though the litmus test that it seemed have laid out in Jan were not met suggests something else was going on and political pressure seems to be the most likely explanation.

Patience

By hiking rates today, BOJ’s Fukui re-establishes some of the appearance of independence that may have been compromised last month. At the same time, though Fukui made it clear that today’s move is not the start of an accelerated sequence of moves. Indeed, in the limited guidance to expectations that he provided, Fukui indicated that further rate hikes will be gradual.

Gradual? The last hike was in July. Another rate hike before Aug-Sept seems unlikely at this juncture. The economic data might not provide such an opportunity in the next several months. The BOJ is forecasting a slowing of producer prices and it is possible that consumer prices have also peaked.

In addition, the politicos are anxious about the April local elections and the upper house election in July. Since being ordained last year, Prime Minister Abe’s public support has waned under a number of gaffes. The ruling LDP needs to a popular mandate to put it in a strong position to raise taxes and cut spending. Just like the BOJ has been unable to normalize monetary policy despite the economic expansion being the longest in modern times, so too has the government been unable to normalize fiscal policy. The budget deficit this year is expected to be just above 4% of GDP.

The yen’s seemingly counter-intuitive losses in the face of the 25 bp rate hike is an acknowledgement by market participants that the move is not sufficient, especially in the context of the BOE’s rate hike last month and the widely expected ECB rate hike next month, to weaken the financial incentives to use the as a financing currency.

Consider what a 25bp rate hike means. It means that all else being equal, it raises the cost of the financing costs by about 2bp a month, half a basis point a week. Even given the low volatility that prevails, the average price swings swamp the extra cost.

There are two factors that might serve to slow the yen’s depreciation in the short-term. One is market positioning. According to the CFTC data, as of last Tuesday, the net non-commercial (speculative) short yen position was a record. Although some short-covering was seen after the stronger than expected GDP figures were reported, the trade remains crowded. Second, seasonally Japanese institutional investors repatriate money back to Japan ahead of the fiscal year end on March 31, only to redeploy the funds at the start of the new fiscal year.

The angst expressed by European finance ministers and the auto sector in Europe and the US are unlikely to be diminished by today’s rate hike, which is unlikely to be repeated in the next several months.