The BoJ has fine-tuned its strategy, setting goals for short and long-term rates. Inflationovershooting commitment guarantees almost unlimited JGB purchases……
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The FOMC meeting left rates unchanged, with indications of a probable hike by the end of the year. While the outcome of the meeting was widely expected, it hides an intense internal debate. As many as three FOMC participants voted against the decision to keep rates stable, and malcontent is widespread among non-voters as well. The decision to keep rates stable was supported by the fact that the move is not urgent: the economy is in a sort of stationary situation, with growth at close to potential, full employment on the labour market, and inflation on a gradual uptrend towards 2%. The assessment of the economy is positive on the whole, and better than it was in July. The statement says that “the case for an increase in the federal funds rate has strengthened but the Committee has decided, for the time being, to wait for further evidence of continued progress toward its objectives”. The FOMC offered an assessment of near-term risks, which “appear roughly balanced”. This signals an impending hike: in July, risks were considered to have decreased, but no open assessment was made.
The main changes to macroeconomic and interest rate projections, extended to 2019, concerned the long-term forecasts of growth (lowered to 1.8%) and the interest rate (down to 2.9%). With respect to the rate path, the extension of forecasts to 2019 has resulted, as expected, in the increases being spread over an extra year; specifically, only two hikes are expected in 2017, as opposed to three in each of the following years. The dot plot shows a solid majority in favour of higher rates by the end of 2016 (14 dots out of 17). However, dispersion is high on the following path. A strong majority still backs further hikes in the years ahead, albeit at an uncertain pace, although the Fed’s guidance has become extremely unreliable. Our forecast is for a rate hike in December, save for unexpected shocks; a move in November, just a few days from the presidential elections, seems unlikely, especially considering that there is no rush to make the move, based on the macro outlook. In 2017, rates should stay put for most of 1H.
The Bank of Japan has defined a “new framework to strengthen monetary stimulus”.
The main changes are:
- “curve control”;
- and 2) “inflation-overshooting commitment”.
In operational terms, the BoJ’s strategy changes on several fronts.
1) Curve control. Monetary policy indications specify a near term policy rate (unchanged at -0.1%) and a target level for the long-term rate (10Y JGB rate of around zero). Purchases will be kept “more or less in line with the current pace”, with a change of around 80 trillion yen. The announcement of the average life of purchases is abolished. The new tools that will be used to aid curve control curve are: i) purchases of JGBs with rates determined by the BoJ; ii) fixed-rate financing operations, with a 10Y maturity (from one year). For the other asset classes, the guidelines previously announced have been confirmed.
2) Inflation-overshooting commitment. The central bank will continue to expand the monetary base until the change in the CPI excl. fresh food rises stably above 2% y/y. The change in the monetary base may fluctuate depending on the operations implemented to control the curve, and the monetary base/nominal GDP ratio will probably by higher than 100% in the span of a year, from 80% at present. The new framework has two stated goals: compressing real interest rates and fuelling inflation expectations, with the commitment to overshoot the target. The changes are unlikely to achieve a significant weakening of the yen and a recovery of inflation, but they do address the issue of government debt sustainability by allowing further purchases of securities even if the inflation target is achieved. In our view, in the end solving Japan’s problem will require a more radical revolution, with the distribution of “helicopter money”: obviously the institutions are still not under enough pressure to change at the root the existing separation between fiscal and monetary policy.
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