How far negative could Bank of Japan send rates?

Japan’s central bank could keep rates lower for longer as the world’s third-largest economy faces the double whammy of next month’s consumption tax hike together with falling exports. But with official interest rates already negative, how low can the Bank of Japan go?

In its latest “Outlook for Economic Activity and Prices” statement released following its 30 July policy meeting, the BOJ said it would continue its ultra-easy monetary policy, “as long as it is necessary” to achieve its 2 per cent inflation target, “at least through around spring 2020”.

However, the central bank also stated it would “not hesitate to take additional easing measures” if it saw signs of slowing momentum concerning its inflation outlook.

The BOJ’s current short-term policy interest rate is negative 0.1 per cent, while it is buying 80 trillion yen ($1 trillion) a year of Japanese government bonds (JGBs) with the aim of keeping the benchmark 10-year JGB yield at zero.

Its quantitative easing policy also entails buying six trillion yen and 90 billion yen, respectively of Japan-listed exchange-traded funds and real estate investment trusts.

Yet despite six years of ultra-easy money, consumer price inflation currently stands at 0.6 per cent and the yield on benchmark 10-year JGBs recently dropped to nearly negative 0.3 per cent.

Amid growing downside risks, BOJ governor Haruhiko Kuroda told Japan’s Nikkei newspaper on 4 September that cutting rates further “is always an option”.

However, Kuroda told the financial daily that such an action was not yet warranted, arguing “we’re maintaining momentum towards [the BOJ’s] price stability target” and “domestic demand – consumer spending and capital investment – are relatively firm”.

Yet economists polled by Reuters have indicated they expect the BOJ to take further action, particularly if the global economy cools further or the Japanese currency strengthens to below 100 yen to the US dollar.

Some 30 of the 38 economists polled predicted the next move would be another easing. Some suggested it could happen as early as this month’s meeting, scheduled for 18 to 19 September.

Among those predicting further easing is Naoki Kamiyama, chief strategist, Nikko Asset Management, who points to rate cuts by other central banks, such as the US Federal Reserve’s recent decision.

“Other central banks are moving into a rate cut direction, so why not the BOJ? The BOJ may be late compared to other central banks, but we think it’s likely the bank will do something in quarter four 2019, during the period from October to December,” he said.

“Our expectation is for a 10-basis point cut to minus 0.2 per cent [for the short-term rate]. We also see 10-year JGBs declining to negative 30 basis points by March 31, 2020”.

Tax constraint

Japan’s latest revised gross domestic product data showed the economy growing at an annualised rate of 1.3 per cent in the June quarter. Slowing capital spending by manufacturers and the US-China trade war have dampened the outlook, while consumer spending will be crimped by next month’s consumption tax hike.

“There’s a possibility growth will turn negative in the October-December quarter,” Totan Research’s chief economist Izuru Kato told Reuters.

“If worries about such negative growth deepen, the Bank of Japan could consider lowering interest rates further into negative territory”.

On 1 October, Japan’s consumption tax rate will increase to 10 per cent, up two percentage points. Worryingly for the authorities, the previous three increases all triggered recessions.

Asked if this time would be any different, Kamiyama was upbeat.

“The last time it was increased, the overall economic conditions weren’t great, government expansion of fiscal policy was insufficient, and it was a three percentage point hike rather than two,” he said.

Next month, Japan’s consumption tax rate will increase to 10pc

Conscious of its potential dampening effects, this time the government of Prime Minister Shinzo Abe has announced offsetting measures including spending 7 trillion yen to bolster infrastructure, along with household subsidies including free early-childhood education.

A reduced consumption tax rate will apply to food and beverages, with further support provided for housing purchases and automotive taxes.

“There’s uncertainty over the effects of these measures … last time it took more than a year for the economy to recover from the tax hike,” Kamiyama said.

Nikko AM expects Japan’s GDP to grow by a modest 0.6 per cent this year, performing “better than consensus” in 2020 thanks to the Tokyo Olympics and potential stimulus measures by China.

For stock investors, Kamiyama sees the benchmark Nikkei 225 ending 2019 at 25,000, dropping to 20,000 by the end of March 2020. As at market close on 6 September, the index of Tokyo stocks was at 21,199, up nearly 6 per cent in calendar 2019 but below its 52-week high of 24,448.

“We’re not too optimistic currently due to the consumption tax hike and US-China ties, which affect sentiment. At the moment we are targeting quality, defensive stocks, but can see the potential to be more offensive next year as China recovers, targeting exporters and also consumption-related stocks,” he said.

Australian investors seeking to participate in the potential upside could consider a Japan-focused ETF, such as the BetaShares WisdomTree Japan ETF (ASX:HJPN), the iShares MSCI Japan ETF (ASX:IJP) (rated “neutral” by Morningstar) or the UBS IQ MSCI Japan Ethical ETF (ASX:UBJ).

In a 30 April ETF research report on IJP, Morningstar’s Donna Lopata commented: “We believe broader global offerings are likely to suit many investors, rather than narrow country-specific ETFs, especially given their higher fees. Additionally, global-equity strategies, which include US exposure are viable alternatives.

“We believe some of our highly rated global equity managers, such as Platinum International, which typically have meaningful Japanese exposure, can continue to do well in the region too. Outside of our coverage, notable active Japanese equity funds include BT Japanese Share and Platinum Japan”.