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Abe Shift on BOJ Shows Volcker Moment May Loom in Japan: Economy

December 18, 2012

Abe Shift on BOJ Signals Japan May Be Approaching Volcker Moment

Shinzo Abe, Japan's incoming prime minister and president of the Liberal Democratic Party (LDP). Photographer: Tomohiro Ohsumi/Bloomnerg

Japan’s incoming Prime Minister Shinzo Abe backed the central bank when it raised interest rates in 2006, a move he now says was a mistake. His shift may signal less tolerance for deflation in the third-largest economy.

Abe, whose party swept to victory in elections for the lower house of Parliament two days ago, will have the chance to reshape the Bank of Japan (8301) next year, when the terms of its governor and two deputies expire. Abe said he told central bank Governor Masaaki Shirakawa today that he wants an accord with a 2 percent inflation target. The BOJ is forecast to boost its asset purchases as soon as Dec. 20.

“This is one of the most important monetary policy events for 2013,” said Bruce Kasman, New-York based chief economist at JPMorgan Chase & Co., the firm ranked by Bloomberg Markets as the No. 1 global economic forecaster. “It could potentially be similar to the major change in U.S. monetary policy after the appointment of Paul Volcker.”

American policy makers by the late 1970s recognized the broader costs of inflation to competitiveness and productivity, and backed then-Federal Reserve Chairman Volcker’s efforts to contain it. Any similar shift by Japan with respect to ending deflation would diminish incentives to save and make it more attractive to borrow, a potential recipe for faster growth.

Shirakawa told reporters that hadn’t discussed monetary policy at his meeting with Abe today. The new prime minister said he told the central bank chief that he had campaigned on ending deflation and correcting a strong yen.

The yen weakened 0.2 percent to 84.01 per dollar as of 3:06 p.m. in Tokyo after touching a 20-month low yesterday on the likelihood of more easing. The Nikkei 225 (NKY) Stock Average closed up 1 percent today, heading for its sixth week of gains, while remaining about 75 percent below a 1989 peak during an investment bubble.

New Policies

Kasman’s colleague Masamichi Adachi in Tokyo said last week that the BOJ may this week adopt a “new style of open-ended asset purchases.”

JPMorgan last week boosted its estimate for Japan’s growth in 2013 to 0.4 percent from zero, accounting for fiscal stimulus pledged by Abe. Seventeen of 21 analysts surveyed by Bloomberg expect the BOJ to ease at a Dec. 19-20 meeting.

While Japan’s entrenched deflation helps retirees preserve wealth, younger generations are hit by falling wages and diminished incentives for borrowing crimp growth. Unemployment among those aged 15-24 was 7.5 percent in October, compared with an unadjusted overall rate of 4.1 percent.

The yen is still stronger than the 100 yen per dollar that Nissan Chief Executive Carlos Ghosn said is the currency’s “neutral range.”

‘Broader Cost’

In the U.S., “people began to recognize inflation’s broader cost and we saw a shift away from viewing it as acceptable,” said JPMorgan’s Kasman. “I don’t think we’ve really seen an aggressive and committed effort to get Japan out of deflation. Political pressures are shifting in a way that may produce that fight.”

Austerity measures in Europe and a territorial spat with China are dragging down Japan’s exports, with the nation’s economy shrinking in each of the past two quarters, meeting the textbook definition of a recession. Big manufacturers are the most pessimistic in almost three years. An aging population and the world’s biggest public debt make it harder to drive a sustained recovery.

“We have to get the economy out of deflation, correct the strong yen, create jobs and boost growth,” Abe said yesterday at a press conference. “That’s our mission.”

Abe, 58, made increased cooperation between the government and the central bank a centerpiece of his campaign, saying Nov. 27 that the BOJ “made a mistake” in stopping quantitative easing amid signs of economic recovery in 2006.

‘Important Lesson’

The BOJ ended its five-year policy of flooding the lending market with cash in March 2006, when Abe was chief cabinet secretary. Four months later, just before Abe became prime minister, the central bank raised its key lending rate for the first time in almost six years. By the third quarter of 2007, the economy was contracting and Abe’s popularity had slumped. He resigned, citing illness.

“The most important lesson Abe must have learned was that the economy matters for his popularity,” said Masayuki Kichikawa, Tokyo-based chief economist at Bank of America Merrill Lynch. “Pushing the central bank may be the easiest solution for now due to the debt burden and because deregulation takes too long to realize.”

Since Abe resigned in September 2007, the Nikkei has fallen by around half as the yen has gained around 40 percent against the dollar, while public debt has grown by a fifth to more than twice the size of the economy.

Government’s Role

“There is a limit to what monetary policy can do,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co. in Tokyo. “The government must try harder to help companies. Expectations on monetary policy are building up in the market but Japan’s economy needs the government to address lowering growth expectations in a rapidly-aging society.”

The two-thirds majority won two days ago by a Liberal Democratic Party-led coalition in the lower house enables it to override most decisions by the opposition-controlled upper house. The upper chamber will have a say on Abe’s picks to replace Shirakawa and his deputies because votes on nominations can’t be overridden.

For now, two former private-sector economists on the BOJ’s nine-member board show signs of favoring more aggressive stimulus, giving Abe the chance to push for a pro-easing majority.

‘Abe’s Revenge’

“This is going to be Abe’s revenge,” said Kazuhiko Ogata, chief economist at Credit Agricole SA. (ACA) “He has rock-solid determination to push the BOJ for more stimulus.”

Elsewhere in Asia, the Reserve Bank of India left interest rates unchanged today for a fifth straight meeting, resisting calls from Finance Minister Palaniappan Chidambaram for lower rates.

Foreign direct investment in China fell for the 12th time in 13 months, suggesting the nation’s rebounding economic growth has yet to attract a fresh influx of capital spending from abroad. China’s new home prices rose in the majority of cities the government tracks in November as property curbs slowed construction.

Minutes from the Dec. 4 meeting of Australia’s central bank showed that policy makers decided to cut interest rates as a softer job market provided room to bolster demand. New Zealand projected a smaller budget surplus in 2015 than in a May estimate.

The U.K. is due to release inflation data today, while the U.S. is forecast to report a current-account deficit for the third quarter. Hungary and Turkey set interest rates.

To contact the reporter on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net


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