Bank of Japan now Faces Crisis of Credibility

The Bank of Japan have embarked on an unconventional communications onslaught to fully elaborate their “comprehensive assessment” of policy, in spite of their actions the recent spate of speeches last week left markets even more confused last week. Two goals were signaled for review by the BOJ governor, Haruhiko Kuroda and his deputy Hiroshi Nakaso to provide a plan on how Japan will handle the issue of negative interest rates in the future and reveal why there is still a great chance that the Japanese economy will achieve its set 2% inflation target.

Kuroda and Deputy Governor Hiroshi Nakaso separately last week highlighted both costs and benefits of the BOJ’s policies, using similar language. They provided analysis on the negative-rate tool and why bond yields fell more than anticipated, along with a recognition of the danger of too-low long-term rates damaging confidence.

“The BOJ communication strategy has totally changed in the past several weeks,” said Masaaki Kanno, Chief Japan economist at JPMorgan Chase & Co. in Tokyo who used to work at the BOJ. “They don’t want to surprise the market anymore.”

Analysts however drew mixed conclusions from the speeches, with some interpreting them as signs that the BoJ will edge away from negative interest rates in the near term and others having the opinion that the BoJ plans a further reduction of the rates possibly lower than the current value of -0.1%. This confusion has brought into the question, the credibility of the BoJ especially after 18 months in which the Japanese economic data looked to be far out of reach of the BoJ’s monetary actions, and their plans of reaching 2% inflation target has been missed repeatedly. This implies that there will be a lot of volatility in yen and Japanese government bonds trading in the days leading to the release of the BoJ’s assessment, which is due at their monetary policy meeting to be held on September 21.

“Some people in the market still seem to believe the BoJ could reduce the amount of asset purchases or back off easing,” says Masaaki Kanno, chief economist at JPMorgan in Tokyo. “I don’t think that’s the BoJ’s message at all. It’s quite likely the BoJ will ease before the end of the year.”

Japan’s consumer price index (CPI) declined at an annualized 0.4% in July, the fifth consecutive month of deflation. That’s not even in the same realm as the BOJ’s target of 2% in “about two years.” That partly explains the BOJ’s crisis of credibility, as policymakers appear to be running out of firepower to reinflate the economy.

The BOJ’s crisis of credibility can also be observed in the currency markets, where the Japanese yen has scored massive gains despite repeated stimulus efforts by the Bank. The yen is up 15% against the US dollar in 2016, having reached multi-year highs on successive occasions. The USD/JPY exchange rate closed at 102.6800 on Friday.