BOJ Moves Reluctantly

The Bank of Japan left the key target rate unchanged at 10 bp, but appeared to bow to government pressure and increased the size of the three-month loan facility arranged last December to JPY20 trillion from JPY10 trillion.

Tweaking this facility was widely tipped as a likely compromise formation between the BOJ who has argued that monetary policy was already extraordinarily easy and interest rates were extremely low, while the government wants more efforts to combat deflation. Nevertheless, the compromise was not satisfactory and two BOJ members (Noda and Suda) dissented.

Japan's CPI fell for the 11th consecutive month in January and the Q4 GDP deflator was a record -2.8%. We agree with the BOJ that today's move will not have much impact, yet the reason we suspect that the BOJ went along was that the JPY10 trillion facility had nearly been exhausted and the banking system fact the imminent withdrawal of liquidity at the end of the month as a separately credit facility (unlimited loans for collateral) was set to expire.

However, it also means that additional measures may require some marked deterioration in conditions. It suggests that the BOJ is reluctant to extend its rinban operations--under which is buys government bonds--from the current JPY1.8 trillion.

Meanwhile the economic data suggests that the capex--export recovery is having knock-on effect on other sectors. The Japanese government appeared to have recognized this early this week, and today it released the Jan tertiary activity report. The 2.9% increase was more than twice the consensus and follows a 0.9% contraction in December 09. The dollar remains largely confined to a JPY90-JPY91 trading range.

Contrary to other analysis, we continue to suspect the risk of intervention remains low, as is normally the case. We note that dollar-yen volatility has fallen to a new multi-year low today below 11.2% and the premium for yen calls over yen puts remains historically speaking (last few years) quite small. Nor do we place much emphasis on the fact that 3-month yen LIBOR has been fixed in recent sessions below 3-month dollar LIBOR. The difference is about 1.5 bp annualized and is simply insignificant to change investment strategies.

The Nikkei's 1.2% advance, led by oil/gas, basic materials and consumer services, brings the month-to-date advance to nearly 7.5%. Foreign investors were increased their purchases of Japanese equities in January, but slowed considerably in February and appear to be stepping back up this month.