TOKYO -- Monetary easing in tough times is textbook stuff. So the market was convinced that the Bank of Japan would serve up additional measures at its April meeting, in light of grim domestic economic data.
The BOJ ignored the textbook; the market gave it a dressing down.
Despite the BOJ's adoption of a negative interest rate policy in January -- whereby it imposes a rate of minus 0.1% on some excess reserves it holds for financial institutions -- the economy has not been performing well. The consumer price index fell 0.3% on the year in March, excluding perishables. It was the first decline in five months. Consumer spending in the same month fell 5.3%, the biggest drop in a year.
The inflation expectations of households and companies -- sets of data the central bank considers crucial -- have been in steady decline for some time. Some economists expect the economy to contract for a second quarter in a row.
No surprise, then, that in a survey of market participants by financial information vendor QUICK, 59% of the 199 respondents said they expected further easing. Instead, what they got was a longer time frame for achieving the BOJ's 2% inflation target and dimmer assessments of the economy and inflation outlook. The central bank essentially admitted that the economy is in a feeble state, yet it made no changes to its asset purchasing program and negative interest policy.
The official explanation from BOJ Gov. Haruhiko Kuroda was that the bank "deemed it appropriate to determine the effects of the negative interest rate policy at this time," and that the policy is "not something that can have an effect in a month or two."
But market players did not like what they heard. A weekend after the BOJ stood pat, the yen stands some 5% stronger against the dollar, compared with the day before the central bank's announcement. The Nikkei 225 fell below 16,000 for the first time in three weeks. That brought the decline in the index this year to 16%, coupled with a 13% surge for the yen against the greenback.
The fact is that investors do not buy the BOJ's official line. Rather, the prevailing view is that the central bank's hands are tied, in one way or another.
The "out of ammo" theory has the most support in the market. This is the notion that the BOJ has nearly exhausted its options. "Monetary policy is coming close to its limit, taking into consideration the large amount of JGBs and ETFs that the BOJ is purchasing," wrote economists from Societe Generale, referring to Japanese government bonds and exchange-traded funds. "When the next opportunity for additional [quantitative and qualitative easing] is taken, the market is likely to feel that a limit has been reached once again."
The economists added: "Although the uncertainty in the global economy has been reduced, there are still risks we need to consider ... The BOJ will therefore probably want to hold on to its last remaining opportunity for additional QQE and maintain its position so it can take action at any time."
Some also argue that political circumstances played a large part in the decision not to act. A Group of Seven accord stipulates that countries should refrain from competitive currency devaluation. Additional monetary easing could be seen as an attempt to weaken the yen, and the theory is that Tokyo did not want to spark that debate just before hosting the G-7 summit in May.
Further shackling the BOJ is the U.S., which put Japan on a new currency monitoring list. "Current conditions in the dollar-yen foreign exchange market are orderly," the U.S. Treasury Department said, adding that it "reiterates the importance of all countries adhering to their G-20 and G-7 commitments regarding exchange rate policies."
Whatever the true reason, Thu Lan Nguyen, a foreign exchange analyst at Commerzbank, thinks the BOJ's inaction may have been the last straw for market participants when it comes to its credibility.
"The BOJ did not react to the sharp drop of inflation expectations, thus confirming the market's fading faith in the BOJ's will or ability to reach its 2% inflation target," she said. "Even worse, the BOJ admitted that it saw downside risks for its inflation outlook. It even revised its inflation projections downward -- again.
"This is what it has come to," she continued. "Who could possibly take the BOJ's inflation target seriously now?"