Published December 17, 2012
TOKYO – Japan's central bank gets its first chance this week to respond to the challenge laid down by Shinzo Abe following his party's landslide victory in a general election on Sunday. Investors are already betting it will flinch.
The Bank of Japan is due to hold its regular monthly policy meeting on December 19-20, giving investors and policymakers outside Japan their first glimpse into how the bank intends to stand up to Abe's campaign pledge to push it into more radical economic stimulus measures, including a big increase in the kind of money-printing tactics already being employed by the U.S. Federal Reserve.
The bank's response could influence global financial markets next year, potentially adding the world's third-largest economy to the growing number of nations experimenting with a policy akin to printing money to revive growth and ease government debt. It will also signal how much independence the central bank can retain under the new government.
Abe, who is due to be confirmed as Japan's next premier on December 26 after his Liberal Democratic Party and an ally won a two-thirds majority in the lower house of parliament, applied fresh pressure on the BOJ 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 told his first post-election news conference. "I hope the Bank of Japan takes this into account (at its policy meeting this week)."
He said he hoped the bank would boost its stimulus efforts this week and double its inflation target to 2 percent as early as in January.
Abe also unveiled a plan to revive a top economic panel, eliminated in 2009 by the outgoing government, where the premier can meet regularly with the central bank governor to debate the feasibility of the bank's policies.
"Once my government is created, I'd like to instruct cabinet ministers to work with the BOJ in crafting a joint statement setting 2 percent inflation as a target," he said.
Fourteen of 19 economists polled by Reuters last week said they expected the BOJ to ease again this week, most likely by increasing its 91-trillion-yen ($1 trillion) asset buying and lending program by up to 10 trillion yen.
The prospect of those additional yen pouring into the economy has helped drive the Japanese currency down almost 7 percent since September.
"The fact that the LDP secured a two-thirds majority gives them a strong mandate and will lead to significant policy changes," said Ian Stannard, head of European currency strategy at Morgan Stanley.
BOJ officials, however, say privately that they fear even an expansion of that size may prove too modest to stave off the heightening political pressure.
Abe campaigned on calls for bolder monetary policy to end Japan's 15 years of deflation and anemic growth, advocating "unlimited" easing to achieve 2 percent inflation, double the bank's current goal, and boost public-works outlays.
Analysts say Abe may also pressure the BOJ to help finance such outlays by boosting its purchases of government bonds.
To preserve the bank's independence, the BOJ is contemplating meeting the demands half-way, according to sources familiar with the central bank's thinking.
The sources said the BOJ may opt for one or two of the following options but not all: agreeing to Abe's higher inflation target, expanding the type of assets the bank buys, investing in a fund to buy foreign bonds that would help weaken the yen, or buying even more government bonds.
"The Bank of Japan is expected to boost bond purchases this week. I wonder whether it will do anything further, as doing too much now would give the impression it is looking at politics alone in guiding monetary policy," said Koichi Haji, chief economist at NLI Research Institute in Tokyo.
Some BOJ officials, particularly those close to its conservative governor, Masaaki Shirakawa, want to delay any action until January when there is more clarity on the new government's policies and when the central bank conducts a quarterly review of its long-term growth projections.
But that may be too costly with business sentiment already slumping and companies delaying capital spending on weak global demand, adding to evidence that any rebound from recession early next year will be minor, analysts say.
"Aside from whether there's political pressure or not, the economy is in bad shape. That's good enough reason for the BOJ to ease this week," said Masamichi Adachi, senior economist at JPMorgan Securities in Tokyo.
Shirakawa's caution may also be overwhelmed by central bank bureaucrats more eager to try new steps, particularly with his five-year tenure expected to expire in April next year.
NEW VENUE FOR DIALOGUE?
The BOJ frets about a possible market backlash. Abe's policy of spending heavily and relying on the central bank for funding could give markets the impression Japan -- already saddled with public debt double the size of its economy -- is losing control of its finances and unleash a bond sell-off, it argues.
Such concern, however, has been ignored by politicians accustomed to leaning on the BOJ for quick stimulus.
Abe revealed a plan to hold regular dialogue with the BOJ governor by resurrecting the Council on Economic and Fiscal Policy, which used to be the government's top decision-making body on economic policies when the LDP was last in power.
Former Prime Minister Junichiro Koizumi used the panel, made of key economic ministers and the BOJ governor, to spearhead structural reforms and set guidelines for drafting the state budget. It was also used as a venue for open debate on the state of the economy and its policy prescriptions. The Democratic Party abolished the panel when it took power in 2009.
Reinstating the body, which the prime minister heads, would give Abe a regular chance to debate with the BOJ chief policy coordination, such as sharing goals on inflation, analysts say.
"The BOJ already says that 1 percent inflation is a target for the time being, so it may strike a compromise with Abe to say that in the long run, it will seek to achieve 2 percent inflation," said JPMorgan's Adachi.
"This panel would be a good place for the BOJ to make its own argument on why deflation can't be beaten by monetary policy alone, although politicians probably won't listen and just keep pressuring it for more stimulus."
The BOJ set its current goal in February and eased policy four times this year, including in September and October, through an increase in asset purchases to ease the pain on the export-reliant economy from slowing global growth.
Central bank executives, including deputy governor Kiyohiko Nishimura, have signaled readiness to loosen policy again soon because of looming risks to Japan's recovery such as the potential pain from the U.S. fiscal cliff early next year.
On Thursday, the BOJ will also announce details of a new loan program unveiled in October to supply banks with cheap long-term funds without limiting the amount of cash made available.
($1 = 83.5000 Japanese yen)
(Editing by Raju Gopalakrishnan)