Capitalizing on his sweeping electoral victory over the
weekend, Japans next prime minister, Shinzo Abe, stepped
up pressure Monday on the Bank of Japan to ease monetary policy
dramatically in an effort to end deflation and jump-start the
Abes center-right Liberal Democratic Party scored
an overwhelming victory in Sundays parliamentary election
after a highly unusual campaign in which he focused his attacks
more on the central bank than on the outgoing government of
Prime Minister Yoshihiko Noda. NHK public TV said Monday the
LDP had won 294 seats in the 480-member lower house of
parliament while its ally, the New Komeito party, won 31 seats,
giving them the two-thirds majority needed to overrule most
matters in the upper house, where Nodas Democratic Party
of Japan holds the largest number of seats.
During the campaign, Abe had declared that the top priority
of an LDP government would be to bring an end to the deflation
that has plagued Japans economy for 15 years. To that
end, he called on the Bank of Japan to double its inflation
target, to 2 percent, and to ease aggressively along the lines
of the U.S. Federal Reserve Board to reach that goal. He also
identified the strong yen as an archenemy of business and vowed
to press for measures, including purchases of foreign bonds by
the BoJ, to weaken it. Abe even threatened to override the
central banks independence if it didnt bow to the
will of the government.
Abe kept up the pressure at a post-election news conference
on Monday. It was very rare for monetary policy to be the
focus of attention in an election, but there was strong public
support to our view, he said. I hope the Bank of
Japan takes this into account when its policymaking body
meets this Wednesday, he added.
Financial markets reacted to the LDP victory by pushing the
yen lower, to 83.78 to the dollar from 83.45 on Friday, and
driving up Japanese stock prices. The Tokyo Stock
Exchanges Nikkei 225 index rose 91.32 points, or just
under 1 percent, to 9,828.88.
Japans central bank has long drawn criticism from
outside economists for its seeming passivity. The banks
determined effort to rein in asset prices in the late 1980s
effectively burst the countrys property bubble and set in
train a lengthy period of stagnation the so-called lost
decades that have produced a stubborn deflation. The BoJ
was slow to adjust to the changed circumstances. It didnt
adopt an inflation target until February 2012 and then set it
at a mere 1 percent, the lowest of any major central bank.
Although the BoJ has bought bonds over the past decade, it has
resisted the bold intervention style and explicit economic
targets adopted by the Fed.
Whats new today is the extent to which the BoJ is
under attack at home. Abe, who served a previous stint as prime
minister in 2006 and 2007, has been notably strident in his
criticism, but he is hardly alone in his attacks. Lawmakers
summoned central bank governor Masaaki Shirakawa to the Diet,
Japans parliament, several times in February 2012 to
criticize his cautious policy approach and urge stronger action
on deflation. The pressure appeared to work, as the BoJ that
month unveiled its inflation target and announced an increase
of ¥10 trillion ($122 billion) in its asset purchasing
But with deflation persisting and Japans economy
sputtering output contracted at a 3.5 percent annual
rate in the third quarter calls for bolder measures have
intensified. Indeed, a new consensus seems to have taken hold.
After two decades of failed stimulus efforts that have left
Japan with the highest debt levels of any major country, while
Chinas economy has overtaken it in size and South Korea
has raced ahead in competitiveness, much of the political class
believes that aggressive monetary easing by the BoJ offers the
last, best hope of ending the countrys long slump.
Politicians of all stripes are very serious now about
the need to end deflation, says one senior bank official,
who spoke on condition of anonymity.
Markets have clearly sensed a shift in policy in the making.
The prospect of easier monetary policy prompted the yen to
slide by more than 5 percent between late September and early
December, while the Nikkei 225 has risen more than 13 percent
Jim ONeill, chairman of Goldman Sachs Asset
Management, says Japans economy, especially its large
export sector, has been hurt by a very overvalued
exchange rate, but he adds that the prospect of a shift
in central bank policy could turn that around. I have
been getting more and more negative about the yen for the past
couple of years, and I have so far been wrong,
ONeill says. But it seems more and more obvious to
me that the moment is here.
Its not hard to see why Abe and others are focusing
their attention on the central bank. The economy has grown at
an average annual rate of barely 1 percent over the past two
decades. Consumer prices have been falling gently for much of
the past 15 years; the annual rate stood at 0.4 percent
in October. Politicians are eager to try anything that might
give the economy a jolt.
A weaker yen could also relieve some of the pressure on
corporate Japan. The currency has eased somewhat since hitting
a record high of 75.31 to the dollar in 2011, but many analysts
believe it is overvalued by anywhere from 10 to 25 percent.
The opportunity in Japan will probably be a currency
opportunity, being short the yen, says Mark Dowding, head
of investment-grade fixed income at BlueBay Asset Management, a
London-based specialist bond manager. I do believe
youre going to see more balance-sheet expansion next
Abes gambit is not without risk. A higher inflation
rate and a weaker yen could drive up interest rates and
destabilize the market for Japanese government bonds. The
countrys low rate levels ten-year JGBs were
trading at yields of about 0.70 percent in early December,
versus 1.56 percent for comparable U.S. Treasuries are
among the main reasons Japan can sustain debt of some 236
percent of gross domestic product.
In its annual review of the Japanese economy, released in
August, the International Monetary Fund warned that a
100-basis-point rise in JGB yields over five years would keep
the debt growing simply because of higher debt-servicing costs;
this would occur even if the government succeeded in
eliminating its big structural budget deficit, which stands
just above 9 percent of GDP. With the countrys fiscal
policy effectively tapped out, the Fund recommended further
monetary easing by the Bank of Japan, including a substantial
increase in asset purchases, to combat deflation and stimulate
the economy. Even if the BoJ does open the money taps, there is
no guarantee that such efforts will produce the desired result.
The central bank may well have been too conservative in the
past, but years of asset purchases have given it a balance
sheet that at roughly 35 percent of GDP is larger than that of
the Fed. And quantitative easing hasnt proved to be a
panacea for Fed chairman Ben Bernanke or Bank of England
governor Mervyn King.
I dont think there will be much impact of
monetary policy on Japans deflation, says Tohru
Sasaki, chief foreign exchange strategist at JPMorgan Chase
Bank in Tokyo. The nominal yield [on JGBs] is already
zero, and what the BoJ is doing is just buying JGBs from the
banks. That does nothing to change inflation expectations. Only
if money goes out [into the real economy] and inflation
expectations go up will the real yield go into negative
territory, and that will make the yen depreciate.
Achieving the center-right LDPs goals would seem
to be a tall order, but Abe nevertheless appears intent on
trying to lift Japans animal spirits by setting ambitious
The political pressure on the Bank of Japan is not an idle
threat. The next prime minister will have the opportunity to
nominate a successor to the hawkish Shirakawa when the bank
governors term expires in April, as well as two deputies.
Those appointments could shift the balance of power on the
central banks nine-member Policy Board to favor the
doves. Three recent appointees to the policymaking body are
thought to support greater monetary easing. If the new
appointees are in favor of the Abe policy, that will make a
majority in favor of further easing, says Rei Masunaga,
former head of the central banks foreign department.
Although Abe has spoken of raising the inflation target as
high as 3 percent, the LDP platform calls for the government to
reach a compact with the central bank to lift the rate to 2
percent. If the central bank doesnt cooperate, Abe has
said the LDP would propose changes to the 1997 Bank of Japan
law to reduce the institutions autonomy in monetary