Dwindling economic activity poses challenge for BOJ

Bank of Japan's (BOJ) asset purchase program known as QQE in short is facing challenges moving into its third year. As of now BOJ is purchasing Japanese assets namely government bonds at ¥ 80 trillion per annum. It remains an open ended program as BOJ has scrapped 2% inflation target by 2015.

Challenges for QQE -

• Liquidity remains atop concern among policy officials. BOJ's share in overall Japanese government bond market has reached beyond one third making the market very vulnerable to BOJ exit as well as large scale wind up by buy side firms.

• BOJ's policy led to weak yen, which in turn makes Japanese economy vulnerable to rise in energy prices. Japan imports most of its energy needs from outside. Weak yen also helps in importing inflation that remains in sharp contrast of BOJ's bid to boost inflation through domestic consumption. Japanese consumers have become more risk and spending averse with general rise in prices.

To add to the headache Japanese economic and industrial activities continue to dwindle. Today's release of March data shows industrial production dropped by -0.8% m/m and -1.7% from a year ago and shipments dropped by -0.6% m/m and -2.3% y/y.

BOJ is left with little tools to boost economy. Further increase in asset purchase is unlikely at the moment and even if increased the effect might be marginal. Yen is to take cues from dollar and broader risk aversion with policy mute from BOJ. Yen is currently trading at 119.6 against dollar.