Steady as She Goes?

Thursday has arrived and so has the BOJ's decision to hold as well. In terms of the general market expectations this is quite surprising since most major analysts predicted at the end of 2006 that the BOJ would raise rates in 2007 starting off with a raise in January. This has not been the case and now of course questions are mounting on the real state of the Japanese economy not to mention market observers who are beginning to question the BOJ's independance vis-á-vis policy pressures from the ministry of finance which has been against a rate raise this time around due to the inability of consumer spending and inflation figures to provide support for such a decision.

(from Bloomberg - bold parts are my emphasis)

The Bank of Japan held its benchmark interest rate at 0.25 percent, averting a clash with government officials who say household spending and inflation are too weak to withstand higher borrowing costs.

The decision was split six-to-three, the bank said today in Tokyo, prompting traders to bet on a February increase. Board members were divided over the outlook for consumer spending, Governor Toshihiko Fukui said.


``The impression that they caved to political pressure is unavoidable,'' said Noriko Hama, professor of economics at Doshisha Business School in Kyoto. ``It's not a bad decision, given the statistics, but it certainly does not look good for the BOJ.''

Moreover, the article also reports how Q4 GDP numbers and general economic data should show a considerable rebound in consumer spending which could allow the BOJ to push rates up in the end of February. I have argued why I don't see this happening but as always we will see. In terms of more coverage of this the FT also has the story.  

Over at Morgan Stanley's Global Economic Forum Takehiro Sato actually apologizes to the readers of GEF that he mistakenly predicted a BOJ hike this time around. Sato initially focuses on the political conflict between the BOJ and Abe's administration and also argues that the BOJ perhaps generally lacks the political clout to persuade policy makers that the normalization process is the right way to go. 

In our view, the additional rate hike in question was never a ‘must’, but our misreading of the forcefulness of political pressure played a part in our error. It is also probably true that the BoJ, though it shifted to a forward-looking monetary policy following the end of quantitative easing, struggled to persuade politicians with its contentions in the current environment where consumption and prices remain sluggish; the BoJ lacked the track record to push this through.

I won't deny this analysis but this is really a question of the proverbial chicken and egg since we might as well also ask whether in fact the economic data has been supporting the idea of a rate hike at all? However, by reading through Sato's analysis we are also told which kind of fundamentals our expectations should be aligned towards. In short; what is in fact the risk of Japan slipping back into deflation and thus the BOJ slippling back in ZIRP at some point in 2007?

The problem is that even if the bank ploughs ahead with a February rate hike for instance, the outlook thereafter is quite uncertain as prices are expected to remain sluggish.  Our official core CPI outlook calls for the baseline to improve by +0.6ppt YoY through January-March 2008, but such high-paced gains are hard to imagine in light of recent weakness.  If the baseline fails to improve, the core CPI could revert to negative territory this spring, spurred by falling crude oil prices, and rather than anchor in positive range in F3/08, could even sink below the water level throughout the year.  If so, we would be forced to retreat from our present scenario of 0.25% rate hikes every six months.  The current hike delay by the BoJ also makes the above less a risk, and more a reality.  We plan to issue another report next week to amend our official outlook on the policy rate, based on the bank’s current policy decision.

As I argued with some force recently we really need to look at the general market expectations on Japan here and ask whether these are viable? In the end, investors and analysists just cannot fight the fundamentals by sticking their head in the sand as an austriche.

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