We don't expect the monetary policy in Japan will change after the new Prime Minister on board. With economic growth remaining sluggish and deflation still a threat, the BOJ will leave the policy rate at virtually 0% at least until 2012. The central bank will also maintain the asset-purchase program and may expand the scope of assets if necessary. With regard to yen's strength, we believe the government has not given up intervention though the impacts so far have not been significant.
Yoshihiko Noda has been elected as Japan's new Prime Minister. The former Finance Minister will be the 6th PM in 5 years. It is expected that Noda will continue the policies adopted when he served as the Finance Minister. Therefore, his succession would probably give the market a sense of stability. There are a series of issues that Noda has to deal with as the new PM: reconstruction works after the Great East Japan Earthquake in March, the change of energy policy after the nuclear crisis that followed the earthquake and tsunami, the recovery of Japanese economic growth and the control of excessive yen appreciation. As far as economic policies are concerns, we believe the mix of fiscal and monetary policies will remain accommodative in the new regime. Being described as a fiscal conservative, Noda suggested doubling the 5% sales tax to fund disaster reconstruction. However, he has toned down this proposal recently. BOJ's independence will unlikely improve and monetary policies will remain accommodative in coming years.
We expect the policy rate, the uncollateralized overnight call rate, will stay at around 0-0.1% through 2012 as Japan's economy has remained fragile and the risk of deflation is still high. The preliminary estimate showed that Japan's economy contracted -0.3% q/q in 2Q11. While it was better than expected, it was mainly helped by government spending and household consumption actually contracted for the 3rd consecutive quarter. Deflation remained a concern in Japan. Although the nationwide CPI (excluding perishables) rose +0.1% q/q in July while the reading excluding food and energy dipped -0.5%, it remained well-below BOJ's target inflation of +1% y/y.
Since 2008, the BOJ has been expanding easing actions, hoping to revive the economy and curb yen's appreciation. In December 2009, the BOJ cut the policy rate from 0.3% to 0.1%. At the same time, it increased the size of outright purchases of JGBs from 14.4 trillion yen to 16.8 trillion yen as well as expanded the range of JGBs accepted in outright purchases. In 2009, it further increased the size of outright purchases of JGBs to 21.6 trillion yen from 16.8 trillion yen in March and introduced 3-month fixed-rated funding operations in December. In August 2010, the BOJ expanded the scope of fixed-rate operations to 6 months. In October, the policy rate was lowered to 0-0.1%. The central bank at the same time established the asset purchase program to buy 2-year JGBs, commercial papers, J-Reits and other assets. The program was expanded twice (March and August) so far this year to stimulate the economy and to curb yen's strength.
Strength in Japanese yen has been a headache for policymakers as it hurts the country's export-oriented economy. The government has adopted intervention for several times but the impacts have been temporary. Last week, the government introduced a new loan facility worth of $100B to encourage domestic companies to invest overseas. The scheme, which will be in effect for 1 year, is expected to weaken the yen as Japanese companies exchange yen for foreign currency to invest overseas. While the measures may help boost the economy and send the currency lower, the impacts are limited. In his capacity as the Finance Minister, Noda had taken firm steps to intervene against appreciation in Japanese yen. He said last month that he would take 'bold' action to curb yen's appreciation and intervention 'is a measure of last resort -- it would be meaningless if it were not a surprise'. Therefore, we believe currency intervention is still on the government's agenda with Noda as the new PM.
