BoJ: Kuroda to suggest ETF purchase tapering as premature - Nomura

Analysts at nomura explained that the BOJ  is unlikely to have a significant impact on JPY. The Bank is likely to upgrade its economic outlook, but its dovish stance will likely remain intact. 

Full report:

"Governor Kuroda is unlikely to indicate any steps towards the Bank’s exit strategy, including the tapering of ETF purchases yet, which may be welcomed by equity investors. As market expectations for easing have declined and concerns about hawkish surprises are likely to exist, JPY may react negatively to Governor Kuroda’s likely dovish policy stance.

Economic forecast upgrade likely

We expect the BOJ to stay on the sidelines again next week (30-31 January). According to local media such as Kyodo the BOJ is mulling the upgrade of its economic forecast in its updated quarterly outlook report, while it may also be considering a minor upgrade in its inflation forecast (unconfirmed).

The Bank upgraded its economic assessment slightly at its previous meeting, and the consensus forecast on Japanese growth has been upgraded recently. Thus, we think the likely upgrade on the economic growth forecast will not be a big surprise for the market. Our economists expect the Bank to upgrade its FY17 growth forecast to +1.5% from +1.3%.

The Bank is unlikely to upgrade its inflation forecast materially, although a small upward revision is possible. Our economists expect the FY17 and FY18 core CPI forecast to be raised by +0.1ppt, but the FY18 core CPI inflation forecast to remain at +1.8%. This suggests the inflation target is not being closely approached. Although headwinds have been shifting to tailwinds, wage negotiations are likely to disappoint the BOJ. The Bank is likely to maintain its cautious stance on the inflation recovery.

The BOJ may announce that it will extend its current loan support programme, which is currently scheduled to finish by end-March 2017. We do not judge the extension as important for JPY trading, though the headlines on the extension could cause volatility in the FX market.

The risk of disappointment is lower

JPY weakened after the BOJ’s previous announcement, although the Bank left its policy unchanged. JPY depreciated on the day of a BOJ announcement for the first time since January 2016, when the Bank announced the negative rate. JGB yields have declined too, while Japanese equity prices rose on the day of the BOJ’s announcement in December.

JPY tended to appreciate after the BOJ announcements in 2016, as market expectations for easing have been high. However, the market’s reaction after December’s meeting suggests investors might not be positioned for BOJ easing surprises, while positioning against hawkish risks.

In fact, after the introduction of the yield curve control policy, market expectations for a BOJ easing have declined. Among BOJ watchers, no one expects the Bank to ease immediately, according to Bloomberg (Figure 2). 90% of BOJ watchers expect both the policy rate (-0.1%) and 10yr yield target (0.0%) to remain unchanged by end-December 2017, according to the JCER (Figure 3). Expectations for easing have fallen further since the previous meeting.

We think lower expectations for easing are reasonable. Governor Kuroda said it is too early to think about tapering or changing the monetary easing position on 18 January (Bloomberg). He also said that we are still a long way before we can think about exiting from the current extremely accommodative policy. According to Bloomberg, the BOJ is also cautious about any hike of the 10yr yield target, even if CPI inflation hits 1%. As core inflation is still below zero percent, the BOJ is unlikely to withdraw its stimulus anytime soon. We do not expect the Bank to consider tapering its ETF purchases.

Governor Kuroda to keep his dovish stance

As market expectations for a change in policy are low, JPY’s reaction to the decision is likely to be muted again. However, Governor Kuroda’s comments on recent market concerns over earlier tapering of the BOJ’s ETF and JGB purchases will be important.

There have been market expectations for a tapering of ETF purchases this year, and Governor Kuroda’s view on ETF purchases will be worth monitoring. At the press conference after the previous meeting, Governor Kuroda said the purchases of ETFs are necessary for achieving the Price Stability Target as early as possible, while the purchases are also aimed at decreasing the risk premium in financial markets. Japanese equity prices are currently trading around the same level as before the previous meeting, while inflation remains low. Therefore, we think there is no strong reason for Governor Kuroda to have a negative view on the BOJ’s ETF purchases at this point. Governor Kuroda’s commitment for the continuation of ETF purchases can be welcomed by the equity market, supporting risk sentiment among Japanese investors.

The Bank surprised the market by skipping the expected 1-5yr JGB purchases on 25 January. As a result of this, the number of 1-5yr JGB purchase operations in January will be five, declining from six times. The Bank already increased the flexibility of its JGB purchases ahead of January, as it stated the frequency of 1-5yr JGB purchases would be about five to seven times, while it had stated about six times until its December schedule. Mid-term JGB yields, for example 2yr yields, have been declining so far this year, as yields have stopped rising globally. 

Thus, we think the decision to reduce mid-term JGB purchases will not be a huge surprise. Upside risks of mid-term JGB yields are also limited as yields up to 10yr are currently capped by two policy variables, the policy rate (-0.1%) and the 10yr yield target (0.0%). We think Governor Kuroda will re-emphasise that the Bank is currently focusing on the yield curve more than the amount of JGB purchases, emphasising the Bank’s accommodative policy stance is unchanged, as the Bank is capping the yield curve well.

The BOJ is also scheduled to update its JGB purchase plan in February after the meeting and press conference (5pm local time). Whether the BOJ would officially decrease the number of 1-5yr JGB purchase operation from five to seven times would be worth monitoring too. If the Bank keeps the number unchanged at five to seven times, market concerns over the rapid JGB purchase tapering would be alleviated.

As the BOJ is unlikely to upgrade its inflation forecast meaningfully, Governor Kuroda’s stance on inflation will probably remain cautious too. He is likely to emphasise the importance of wage negotiations, but we expect the negotiations to disappoint the Bank again this year.

Governor Kuroda also suggested he was comfortable with JPY weakness at the previous meeting, when USD/JPY was trading around 117-118. Governor Kuroda is thus likely to suggest a neutral to positive view on JPY weakness, which is necessary for the BOJ to achieve its inflation target.

Conclusion

Although recent market expectations on the tapering of ETF purchases and the recent decision to skip a 1-5yr JGB purchase operation may have increased market expectations on hawkish surprises from the BOJ, we still believe Governor Kuroda is going to maintain his dovish stance. The risk of a hawkish surprise is very limited.

USD/JPY has been driven by US rates and concerns about US FX policy recently, and we do not see the BOJ meeting next week as a catalyst for significant movements in JPY.

Nonetheless, the BOJ’s dovish stance should widen the rate differential between the US and Japan gradually, as the yield curve control policy is capping upside risk of JGB yields well. The likely dovish stance unveiled at next week’s meeting should be JPY negative gradually, in our view."