Will the BOJ Do Whatever it Takes ?

The ECB has promised dramatic action to save the euro.  The Federal Reserve has announced it will expand its balance sheet until well after the economy recovers.  Attention turns to the BOJ whose two-day meeting concludes on Wednesday.  The BOJ did increase the  size of its asset purchase program in February and April, but it has been generally reticent about committing itself like the Fed and ECB "to whatever it takes" within their mandates.

While the BOJ may tweak its policies this week, pressure will likely have to mount further to get it over its hump. For example, despite a range of opinion, it appears that there is a strong sense that buying foreign bonds is too close to intervention for the BOJ to initiate it.


Such tweaks may include a modest increase, say JPY10 trillion, in its asset purchases.  It could adjust what it is buying.  It could eliminate the  minimum bid.  It could extend the duration of its asset purchases from the current deadline of mid-2013.    So what?   Why pretend that it is not pushing on a string?

Credit is cheap and abundant in Japan.  The  BOJ's own senior loan officers shows that credit has been easier to obtain every quarter over the past two years.  Practically no matter what the BOJ does, it will remain behind the curve.  Not only is Japan still experiencing deflation by the BOJ's preferred core measure (-0.3% year-over-year in July), but the economy appears to be stalling, if not worse.

The Japanese government lowered its assessment of the economy two consecutive months now.  Growth in the April-June quarter was cut in half to 0.7% from the government's initial estimate and next quarter has begun off poorly.  Industrial output was expected to have risen in July by 1.7% but instead fell 1.2%.   The end of government subsidies for fuel efficient cars saw auto sales plunge 11% in the month of August.  The output measure of the latest PMI reading is at a 17-month low.

The calendar suggests that if not now, the BOJ is likely to act by the end of next month.  It will have more somber data to look at, including the quarterly Tankan Survey.  It's month-end meeting also corresponds with its semi-annual economic outlook update.  In addition, it will have a better handle on what the ECB and especially the Federal Reserve's policy impact on the yen, which traded at 7-month highs against the dollar following the Fed's announcement last week.

Political pressure will also mount.  Presently the opposition has succeeded in blocking the government's bond sales to fund this year's deficit in order to force an election, following the passage of the controversial retail sales tax increase.   All the main political parties have the ending of deflation in their manifestos.  There also seems to be a consensus emerging that the BOJ and MOF have to work in closer cooperation. This could be yet another sign that the crisis response is eroding the independence of central banks.

The risk of material intervention seems slight.   It is difficult for the Ministry of Finance, whose call it is, to justify intervention.  Indeed, given the increased territorial dispute with China, Japanese officials may want to use their political chits for larger issues.

The break down of the dollar below JPY 78 was brief and it  has quickly returned to the range seen since mid-July.  On a trade-weighted basis, the yen has weakened about 4% from its peak in late July.  Past G7 statements have cautioned against excessive volatility, but this cannot be reasonable claimed now.  The benchmark 3-month dollar-yen volatility fell to about 6.8% last week, its lowest level since at least September 2007.   It has firmed a bit in recent day to stand below 7.6% currently.  The 100-day moving average is bear 8.4%.    The speculators at CME aree are net long yen, but still have a relatively modest position.  The 3-month risk reversal favors dollars calls over puts and by the most since at least 2003 today, showing no bullish skew for the yen.