The markets expected Developed Economy policy makers (Japan and UK in this case) to be dovish and they were. In Japan, while the Bank of Japan (BoJ) left policy rates unchanged, there was a fiscal stimulus package worth ¥28.1 trillion (to help give loans to SMEs that may suffer from Brexit); whereas in the UK, the Bank of England (BoE) cut the policy rate and proclaimed to purchase corporate bonds.
An important question here is whether they met market expectations and how did the policy announcements impact different asset classes?
BoJ and BoE Market Expectations
Before their respective meetings, the market participants had the following expectations:
BoJ’s Policy Announcement
Shinzo Abe propounded the three arrows of Abenomics – fiscal stimulus, monetary stimulus and structural reforms – to revive the Japanese economy from the two-decades of recession. The initial hype resulted in a positive reaction from the markets (currency depreciation and rise in equity prices). Although the inflation target of 2% was not achieved, the modest inflation was an improvement compared to Japan’s deflationary past. However, Abenomics failed to live up to the initial hype. (Click here to know more)
In April 2014, a consumption tax increase led to fiscal tightening (deviation from the stated arrows of Abenomics). This adversely impacted household spending and private investments. The modest recovery soon degraded into another round of economic recession. (Click here to read more about Deflation in Japan)
BoJ announced the following steps in the meeting to address the recession:
- No rate cut & maintained its Quantitative Easing of ¥80 trillion.
- Increased the scale of a program to buy exchange-traded funds (ETFs) to ¥6 trillion a year from ¥3.3 trillion. (BoJ Policy Statement).
BoE’s Policy Announcement
The uncertain implications of Brexit was the major cause for status quo in the previous meeting of the BoE. However, the significant policy easing in the latest meeting clearly indicates that the BoE wanted more clarity on Brexit’s economic implications before committing to a major policy announcement. (Click here to read more about implication of Brexit on UK)
The Monetary Policy Committee (MPC) decided to take the following steps to provide additional support after the Brexit poll and to reach its target inflation of 2%.
- Cut the bank rate by 25 basis points to 0.25% – 322 Year low!!
- Introduced Term Funding Scheme (TFS) in order to pass-over the lower rates to the customers.
- Purchase of £10 billion of the UK corporate bonds over a period of 18 months and expansion of sovereign quantitative easing by £60 billion (buying UK Government Bonds over a period of 6 months) (Click Here to know more about BOE measures)
Impact on Markets
Immediately after the announcement:
- Currency – Yen appreciated by 1% whereas the pound crashed by 1.6 %. It was the biggest fall of pound since Brexit Referendum.
- Bond Yields – 10-year JGB Yields rose to -0.2% from -0.3% whereas 10-year UK bond yields fell to a record low of 0.639%.
- Stock Index – The Nikkei Average tumbled by 2% as BoJ’s policy statement fell short of expectations whereas the UK FTSE climbed by 1.6% led by financial shares.
Opinion on BoJ’s action – Expectations not met on monetary policy front
In its policy statement, the BoJ mentioned that it eased monetary policy to cope with growing uncertainties in overseas economies and a rise in the global financial market volatility owing to Brexit vote and slowdown in EMs. The main objective of the actions was to help prevent these uncertainties from leading to loss in investor and business confidence.
However, contrary to market expectations, the BoJ did not cut the policy rate. The probable reason is that the BoJ wanted to get some more time to build consensus especially as banks and other financial firms have opposed BoJ’s JGB purchases and negative interest rate policy. In fact, there wasn’t any specific mention about inflation in its Monetary Policy Report and its downside risks. Given the government actions, it seems that government believes that monetary policy has become less of an effective tool to boost GDP and induce spending.The announcement of fiscal stimulus suggests a move towards the original Abenomics principles to kick start the Japanese economy.
Opinion on BoE’s action – Exceeded expectations
Given that Brexit implications are still unclear, the BoE’s stance indicates a front-loading of easing to effectively communicate that the BoE is in control of the situation. Even though BoE chose to cut rate by 25bps, it exceeded market expectations on several other fronts –
- The term Funding Scheme – lending up to £100 billion to banks at a generous rate, close to the bank rate for four years – will ensure that base rate cut is passed through to households and companies. Click here to Know More
- Buying the UK corporate bonds, starting September, would further drive down borrowing costs for companies, helping inculcate credit growth.
Future Expectations
- The BoJ announced that there will be a comprehensive review of its policy framework at the next meeting on September 20-21. The main intention is to do a comprehensive assessment of developments in economic activity and prices under Quantitative Easing with Negative Interest Rates. The report will form the base for a concrete interest rate decision on rates in the September or November meeting.
- As stated in the BoE report, it is expected that they might further cut rates. Majority of members are expected to support a further rate cut and provide more easing measures at one of MPCs forthcoming meetings during the course of year..
Things to look out for
We will give some interesting trade ideas based on the above policies and market actions. Please keep a look out in this space in the coming few days.
Rishi Vora, Dinkar Mohta and Punit Parekh
Disclaimer – All the views expressed are opinions of Networth – IIMB Finance Club – members. Networth declines any responsibility for eventual losses you may incur implementing all or part of the ideas contained in this website.
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