Surprise BOJ move paves way for 10% sales tax

Kyodo, AP

It appears clear that Bank of Japan Gov. Haruhiko Kuroda is pressing Prime Minister Shinzo Abe to raise the consumption tax again next year as legislated to improve the country’s fiscal health despite concerns it could further slow economic recovery.

The central bank’s move to expand its unprecedented monetary easing program was the first since it was launched to battle deflation with massive purchases of government bonds and bank assets in April 2013.

The benchmark Nikkei 225 stock index closed Friday at a nearly seven-year high as the yen sank further against the dollar to levels unseen in more than six years.

“I didn’t expect additional easing to come this year,” Masaaki Kanno, chief economist at JPMorgan Securities Japan Co., said.

The surprise move, which will pump trillions of yen more into the financial system, is intended to stimulate lending and spending in the world’s third-largest economy.

But it’s also an acknowledgement that Abe’s government has so far failed in its broad efforts to revive growth, especially after the first stage of the doubling of the 5 percent sales tax, which raised the levy to 8 percent, took effect in April.

According to the latest data, consumer spending is falling, unemployment is rising and inflation is slowing further.

By injecting more money into the economy, the government hopes to raise public expectations for stronger inflation to spur spending and fuel growth.

The move was striking in its timing. It comes two days after the U.S. Federal Reserve did the reverse by ending its own quantitative easing program, which had pumped over $3 trillion into the U.S. economy over the past six years. The Fed is pulling back because, in contrast to Japan, the U.S. economy is showing consistent improvement.

Kuroda had kept saying the BOJ’s “quantitative and qualitative easing” was exerting the intended effects on the economy and lifting prices toward its 2 percent inflation target, making any additional action appear unlikely, at least in the near term, to most market watchers.

The yen had already sunk to multiyear lows against its major counterparts because of the BOJ’s radical program. After failing to boost exports as hoped, the weaker yen is increasingly being viewed as problematic for inflating the cost of living and doing business by raising the cost of imports, such as fuel.

Yet the BOJ drove the yen down further Friday, raising its goal for expanding the nation’s monetary base at an annual pace of about ¥80 trillion instead of between ¥60 trillion and ¥70 trillion. The central bank may believe these steps will produce stable growth and inflation and thus encourage the government to follow through on doubling the sales tax, despite fears of another slowdown in consumption and industrial output.

Harumi Taguchi, an economist at IHS Global Insight, said the BOJ was spooked by signs the economy could slip back into deflation. A stricter consumer price index dubbed “core-core CPI,” which excludes the volatile prices generated by food and energy, has fallen to nearly 1 percent, Taguchi noted. Falling oil prices could push overall inflation even lower, with the doubling of the sales tax to 10 percent next year threatening to weaken spending and growth.

The BOJ’s action “has significance as a strategic move to create an environment where the government can easily decide to raise the (sales) tax again,” Kanno said.

Abe will make the final decision later this year after examining economic data for the crucial July-September quarter. Kuroda has stressed the need to follow through with the October 2015 tax hike to address Japan’s deteriorating public finances as welfare costs snowball for the rapidly aging population.

Another explanation of why the BOJ unexpectedly eased policy, although denied by Kuroda, is that the central bank moved in lock step with the government, staging a surprise for market participants.Japan’s giant public pension fund, the biggest in the world, announced the same day that it will review its portfolio and double its purchases of Japanese stocks, another piece of news that sent the Nikkei soaring.

The ¥127 trillion Government Pension Investment Fund said ti will cut its holdings of Japanese government bonds — the biggest chunk of its portfolio. The BOJ, meanwhile, will gobble up even more JGBs from banks under its expanded easing program, potentially addressing concerns that the unloading of JGBs by the GPIF will trigger a spike in long-term interest rates that could bankrupt Japan by jacking up debt-servicing costs.

“The monetary easing is aimed at making the BOJ a buyer of government bonds the GPIF will sell in the allocation review,” said Ryutaro Kono, chief economist at BNP Paribas Securities.

But such a scenario appears to be causing chagrin among BOJ officials who believe that monetizing the debt will only harm Japan’s economic and financial stability. In Friday’s rare split decision, four of the nine members of the BOJ Policy Board voted against the move. Their reasons were not disclosed.

Despite the split, Kuroda said all are aware of the risk that if the recent downward pressure on prices, most notably from plunging crude oil, is left unchecked, the economy will not be able to exit nearly two decades of deflation.

The BOJ is accelerating its drive to achieve the 2 percent inflation target by “sometime next year” while urging the Abe government to improve fiscal discipline and maintain confidence in Japan’s debt. But if the weak yen continues to hurt the economy, the BOJ will have to review its own plans.

“Rising costs following the yen’s sharp fall could adversely impact regional economies as well as smaller businesses,” said Kyohei Morita, chief economist at Barclays Capital Japan.