In August, the BoJ announced a ‘comprehensive review’ of its recent monetary policy at the September meeting, taking a look at what has worked and what hasn’t and trying to get it right going forward. It will be interesting to see if the two-year timeframe for achieving its inflation target of 2% is maintained.
Will the BoJ take the deposit rate deeper into negative territory from the current levels of -10 basis points? The bank currently targets various assets purchases which equate to the bank expanding its base money by ¥80 trillion a year. There are handful of economists who believe it could increase the annualised pace to ¥100 trillion, although the consensus is that the bank will leave the pace of asset purchases unchanged. Clearly expanding the monetary base more aggressively will promote JPY selling, whereas leaving it as it is could fuel fears about uncertainty around the sustainability of its quantitative easing program.
My belief is that the BoJ will try and create a sense of flexibility, moving to a range of ¥70 trillion to ¥100 trillion and telling the market that the actual level of bond buying will be conditional on reaching the inflation target. The bank may look at new assets to buy, such as infrastructure or local government bonds.
Taking the deposit rate deeper into negative territory could have far-reaching implications within the Japanese banking system, and if it does cut the deposit rate it will need to offset the impact with measures that support banks' earnings. For clarity, the deposit rate is effectively a charge on any reserves held on the Bank of Japan’s balance sheet, representing a cost to a bank’s net interest margins.
Rather than try and second-guess what a central bank will or won’t do, I think it’s always wise to watch price action. The playbook around the meeting is broad and uncertain and there is no one clear change in monetary policy that will cause an obvious reaction in financial markets. The market should tell you all you need to know.
If we specifically look at the JPY crosses such as EUR/JPY, we can see the JPY bulls are starting to get quite excited about the Bank of Japan disappointing expectations at tomorrow’s meeting.