 s
was feared, Japan has reversed most of its September monetary stimulus.
Through October 9, commercial bank reserves have fallen to 7.2 trillion
yen ($60 billion) from 11.1 trillion yen at the end of September.
The monetary base has contracted by a similar degree.
The October
tightening of monetary policy is harmful given the country's ongoing
deflation. Tokyo CPI prices fell 1.2% in the 12 months through September,
yet Bank of Japan Governor Hayami expressed concern about inflation
in his October 9 testimony to the Diet. Expect the fallout from
the latest BOJ tightening to show up in further equity weakness.
Commercial
bank reserves held at the central bank (a measure of liquidity)
rose from 5.4 trillion yen at the end of August to 11.1 trillion
yen at the end of September. The BOJ and the Ministry of Finance
were responding to September 11, the end of the half-year on September
30, and the strength of the yen.
Of the 5.7
trillion yen expansion in September, roughly half came through a
2.3 trillion yen ($19 billion) addition to international reserves
due to the currency intervention. Japan was leaning against the
yen strength that occurred after September 11. In effect, the BOJ
printed yen, bought dollars, and left the yen unsterilized in the
banking system where they showed up in bank reserves at the BOJ.
The rest of
the September liquidity came through a quantitative easing of monetary
policy. In effect, the BOJ printed yen to purchase government debt.
This pushed interest rates somewhat lower (since reversed).
In a previous
NRO Financial piece, the pattern was noted:
In past half-year instances, Japan has given the impression
of constructive monetary policy changes, then promptly reinstalled
a deflationary policy. For example, in March 1999, the Bank of Japan
injected overnight liquidity, cut the interest rate fractionally,
and allowed a public discussion of a shift from interest-rate targeting
to quantitative — then it reversed the impact. In March 2001,
the BOJ finally shifted to a quantitative target, but set a deflationary
level and left it unchanged for five months.
The near-term
direction of the yen will depend on war news. The yen strengthened
after September 11. It weakened in late September on the Japanese
intervention in the foreign exchange markets. By sterilizing the
intervention in recent days, the BOJ seems to be inviting yen strength
and undermining the credibility of its future foreign exchange interventions.
However, the Japanese economy is weakening so fast that there is
a fundamental reason for yen weakness. The balance might be near-term
yen strength in the event of any troublesome news on the war front,
but medium and long-term yen weakness as Japan's recession becomes
deep.
In sum, Japan
has already sterilized more than half of the September monetary
stimulus. This tightens monetary policy, pointing toward an even
deeper recession. It also further lowers the economic credibility
of the BOJ and the Japanese government.
To grow, Japan
has to stop its deflationary monetary policy, adopting instead a
policy of price and yen stability (a price-rule monetary policy).
In the meantime, we expect further deterioration in the economy
and an increase in bad loans and bankruptcies, with a negative impact
on equities.
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