To ease or not to ease; weak oil, wild markets put BOJ in tight spot

TOKYO: The damage done by plunging oil prices and global markets to the Bank of Japan’s hopes of achieving 2 percent inflation could prompt policymakers to consider easing monetary policy further next week, sources familiar with its thinking say.

With the outcome of the two-day policy review hanging in the balance, how financial markets behave in coming days could determine which way Japan’s central bank sways next Friday.

Advocates of an expansion of the BOJ’s already massive stimulus will face opposition from those who question the merits of using a dwindling supply of policy ammunition to battle headwinds driven by market forces beyond the central bank’s control.

Even though a precipitous drop in oil prices has brought consumer inflation to a halt and made the BOJ’s 2 percent target more elusive, BOJ Governor Haruhiko Kuroda has stayed optimistic that a steady recovery is underpinning a broad uptrend in prices.

Within the central bank, however, policymakers fear that the severity of the oil rout could dent people’s expectations for higher future prices, which would hurt business sentiment and discourage companies from raising wages.

At least four of the BOJ’s nine board members are wary of topping up an already massive asset-buying program that is drying up bond market liquidity and has had little success in boosting inflation expectations.

They argue that, despite flirting with recession, Japan’s economic fundamentals are strong enough to weather the market storm, and prefer to wait until there is more clarity on whether the turbulence will last long enough to inflict real damage on corporate profits.

“When markets are so unstable, the best thing a central bank can do is to stay calm and hold tight,” said an official directly involved in monetary policy.

Others believe doing nothing, and letting inflation expectations slip, could hold greater dangers to the BOJ’s campaign to wrench Japan’s economy out of years of debilitating deflation.

“If such second-round effects materialize or become hard to ignore as near-term risks, the BOJ should take action,” said a second official. Another expressed a similar view.

Kuroda himself identified the global market turbulence as a key risk to the outlook, telling parliament on Thursday that he was “carefully watching” the fallout on the economy and prices.

The BOJ has said it will look beyond the effect of oil on inflation and focus on the broad price trend, which it sees as improving as consumers become more accepting of price rises.

The BOJ is likely to cut its inflation forecast for the coming fiscal year to possibly below 1 percent at the policy review next week, sources have told Reuters.

Recent surveys showed household and corporate inflation expectations are weakening. Companies remain reluctant to spend their record profits on wage hikes, underscoring the sticky nature of Japan’s deflationary mindset.

The government has begun signaling hopes for BOJ action to help stem the market rout. “The BOJ governor has always said he won’t hesitate taking action, including additional monetary easing, to achieve the 2 percent inflation target,” top government spokesman Yoshihide Suga told reporters on Wednesday.

While Kuroda is expected to win enough votes to push through easing if he sees the need, the close vote may cast doubt on his leadership and heighten market views that the BOJ has nearly exhausted its policy options, some analysts say.

With no set piece of data available to measure the second-round effects of oil falls, next week’s policy decision will be a close call and may depend on how financial markets behave in the days leading up to the meeting, they say.

“The BOJ is in a really tight spot. Failure to ease could trigger an unwelcome yen spike,” said Masamichi Adachi, senior economist at JPMorgan Securities.

“But even if it does
ease, it risks underwhelming market expectations unless it comes up with something very radical. That’s quite a challenge.”

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