Will Bank of Japan's innovations halt declining inflation expectations?

Bank of Japan's (BoJ) policy meeting today concluded with no change made to the contentious -0.10 percent policy interest rate or the main asset purchase volume targets (JGB purchases will be maintained ‘more or less’ in line with the current pace of increase of ¥80trn per year). The BoJ announced significant innovations to its policy framework as it unveiled a range of new measures.

The BoJ is aiming to control the slope of the yield curve – by targeting short- and long-term rates - and at the same time continuing to expand the money base. To achieve that aim, the BoJ will conduct fixed-rate purchase operations right across the curve, from maturities of 2Y up to 40Y. And to give itself greater flexibility regarding the relative amounts of bonds it will buy at different maturities, the BoJ abandoned its previous guideline average maturity of 7-12Y for its JGB holdings.

With regards to inflation, the BoJ maintained its objective to achieve the 2 percent inflation target ‘at the earliest possible time’. Also, it made a new commitment to strive to overachieve. The BoJ also highlighted in a separate paragraph under the title “Possible Options for Additional Easing” that both cuts in the short-term policy interest rate and the target level for long-term yields were possible going forward as was a further expansion of asset purchases.

"Given the relatively limited support coming from fiscal policy; Japan’s woeful demographics and other structural weaknesses; the weakness of global demand; and the susceptibility of the yen to bouts of swings in global risk aversion, we very much doubt that – for all the BoJ’s efforts – inflation will manage even to rise significantly above 1%Y/Y on a sustained basis. So, this is unlikely to be Kuroda’s last word. Indeed, there seems reason to expect further easing – perhaps via a 10bps cut in the policy rate to -0.20% (with the 10Y yield target left unchanged at zero) – next year." said Daiwa Capital Markets in a report.

The announcements are unlikely to eradicate the skepticism in the market over the BoJ’s ability to achieve its inflation goal. There is nothing in today’s announcement to make the yen bearish. The BoJ to remain under pressure to ease its monetary stance further if they are serious about achieving an inflation overshoot. Potential for action may help limit yen strength but without an uptick in inflation expectations, the yen is likely to advance further.

USD/JPY has managed to bounce modestly on the BoJ’s decision to announce a shift in stance. But the major has pared gains to currently trade 0.27 percent lower on the day at around 101.41 at 11:15 GMT. The major remains capped below 20-day MA at 102.30. Only close above to see further upside.  Momentum studies are bearish, scope for downside upto 99.53 in the coming weeks. Of course all eyes this evening will be on the Fed’s policy announcement for clues on further direction.