Chief economist update: A prelude to taper?

The Bank of Japan's (BOJ) announcement that it's trimming ¥10 billion off its purchases of 10 to 25-year and 25 to 40-year JGBs sent the Japanese yen 0.5% higher against the US dollar to ¥112.43 after it sparked renewed taper speculations.

While Bloomberg points out that this was merely a "minor tweak" and that "the actual increase was only around 58 trillion last year" - less than the written promise of ¥80 trillion - the sharp improvement in Japan's economic fundamentals over the past few months give more merit to this renewed bout of taper thoughts.

After many months of expressing its optimism on the country's outlook on growth and to a lesser extent, inflation, the Bank of Japan's (BOJ) long-hoped for "virtuous cycle" has started to turn.

This was not lost on the BOJ. While the Japanese central bank kept monetary policy unchanged at its December 2017 meeting, the policy statement was more upbeat: "Japan's economy is expanding moderately, with a virtuous cycle from income to spending operating."

Yes folks, the "virtuous cycle" is now in operation and is expected to keep on turning: "Domestic demand is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the household and corporate sectors, on the back of highly accommodative financial conditions and underpinnings through the government's past stimulus measures."

Japan's labour market stats indicate it would. Japan's unemployment rate fell to a 24-year low of 2.7% in November with the jobs-to-applicants ratio rising to a 44-year high of 1.56 in the same month.

Not surprisingly, wages are starting to pick up. Growth in average monthly cash earnings accelerated to 1% in the year to November - the fastest in 16 months - and with it (and the wealth effect from the soaring stock market), increased consumer spending. Retail sales increased by 2.2% in the year to November, more than offsetting the 0.3% decline recorded in the previous month.

To be sure, it's still early days and Japan's history is littered with reversals. The present case could turn out to be another, particularly if the yen continues to strengthen in anticipation of some withdrawal of stimulus from the BOJ.

The stronger yen would precipitate a correction in the Nikkei-225 index, erode Japanese exporters' competitiveness, reducing export earnings and, more importantly, place renewed downward pressure on inflation.

Thus, the recent market reaction to taper speculations would instead ensure that the BOJ would continue with its policy "Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate" and "expanding the monetary base until the year-on-year rate of increase in the observed CPI (all items less fresh food) exceeds 2% and stays above the target in a stable manner."

Ben Ong is the Director of Economics and Investments at Rainmaker Group. He previously worked as a portfolio manager and central banker before joining Rainmaker. Check out his economics analysis here.

Read more: BOJtaperBank of JapanBloombergCPItrim
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