International | Jul 12 2006
By Chris Shaw
The Bank of Japan (BOJ) meets this week (Friday) and is widely expected to lift official interest rates by 0.25%, with further increases in future months seen as likely by many in the market.
GaveKal Research doesn’t share such a view, cautioning against assuming a rate rise may come this week (it disagrees with this assessment as it expects no move on official rates prior to September) and that further increases will follow. The experts, never afraid to take an opposing view, suggest such a view ignores statements already made by the BOJ.
The statements it is referring to are comments by BOJ officials pointing to differences between the policies of Quantitative Easing (QE) and the Zero Interest Rate Policy (ZIRP). Quantitative Easing, which involved flooding the system with liquidity, has now finished, with the BOJ instead moving to drain the excess liquidity from the banking system in recent months. But GaveKal suggests the ending of the QE policy doesn’t also signal an automatic end to the ZIRP, as there are a number of reasons such a move doesn’t make sense.
Firstly, it points out the BOJ has already made clear its intention to allow some time for the banking sector to adjust to the end of QE and the lower liquidity now in the system. Even assuming a rate increase between now and September, such an adjustment period would make a further increase in rates unlikely before Christmas. GaveKal suggests the market should be setting its sights on official rates of no more than 0.5% by the end of the Japanese financial year next March and probably not more than 1% for the remainder of this decade.
This may even prove optimistic as GaveKal suggests any indication of an impending global financial crisis would likely persuade the BOJ to hold off on further increases, while a significant slowing in global growth would also be persuasive in stopping further increases.
This second outcome is more likely as GaveKal suggests the evidence should soon point to a slowing in both the US and European economies, a development likely to result in a stronger yen but weaker Japanese exports, an outcome that would give some cause for concern given the important role exports have played in Japan’s economic recovery.
Another factor GaveKal points to in supporting its view is Japan simply has poor demographics, as the population is now in decline and productivity growth remains weak. Both of these factors are negative for the rate of economic growth, so if there continues to be downward pressure on GDP growth there is likely to be downward pressure on interest rates also.
As a result, GaveKal suggests such pressure makes it much easier for the BOJ to justify smaller than expected increases in official interest rates, a factor it believes the market is currently discounting.
