Global Economic Perspectives:The Bank of Japan Reassesses Policy

　　The BoJ's Monetary Policy Board meets on Sept 20-21and will bepresented with a "comprehensive assessment" of the effectiveness ofits policies, which it had in July commissioned the staff to prepare. Weexpect that report to conclude, as did an earlier assessment in 2015, thatasset purchases had been successful in driving down funding costs andpushing growth and inflation higher. We expect they will also concludethat the introduction of negative interest rates in January this year had apowerful complementary effect.

　　The report will likely conclude that exogenous shocks – the decline inenergy prices, slower Chinese growth and weak US and European activity– a larger-than-expected decline in demand after the 2014consumptiontax increase and strongly backward-looking inflation expectations areresponsible for the failure to meet the 2% inflation target as expected.

　　The most likely course of action for the Board, therefore, will be to leavepolicies unchanged on the basis that as these exogenous effects wearoff inflation and inflation expectations will both rise. Any reduction in thedegree of policy accommodation is extremely unlikely, in our view.

　　But possibly, either next week or later in the year (perhaps October), theBoard will reconfigure policy to gain more flexibility in terms of the paceand types of asset purchases to address concerns about illiquidity atthe long end of the bond market. To prevent this being interpreted as atightening of policy, such a measure would likely be accompanied by a cutin the interest rate on the Policy-Rate Balance of banks' current accounts.

　　To address concerns about the negative impact on bank profitability froma rate cut, this might be combined with either unchanged interest rateson the rest of banks' reserves or a merging of the Basic and Macro Add-On balances at a positive interest rate.

　　A steepening of the yield curve is a likely outcome of such a policypackage. This is especially likely because we think negative rates havenot been as beneficial as the BoJ is likely to conclude. Indeed, we thinkthe introduction of negative interest rates has been counter-productivewith the costs outweighing the benefits, contrary to the Bank's likelyassessment. It would take an implausibly large rate cut to offset theimpact of even a modest reduction in bond purchases, in our view.