Bank of Japan opens the floodgates

http://blogs.ft.com/gavyndavies/2014/11/02/bank-of-japan-opens-the-floodgates/

20141103 By Gavyn Davies

Very good

Markets and policy makers will now watch the Japanese experiment even more carefully than before. If it fails to restore inflation to Japan, this will be taken as a sign that monetary policy everywhere is powerless in the face of the deflationary forces that appear to be gathering momentum in the world economy.

The lessons will of course be particularly salient for the euro area. In many ways, Japanese thinking on monetary policy has now become the inverse of the ECB’s.

Under Mr Kuroda, the BoJ has deliberately sought to take the markets by surprise, maximizing the announcement effects of QE by shocking the markets. The ECB, in contrast, seems always to raise market expectations ahead of each of its monthly meeting, only to disappoint consistently when the decisions are finally reached.

The BoJ has also relied deliberately on buying sovereign debt, while the ECB has eschewed this (though its parallel actions on the regulation of pension funds does mean that the BoJ will effectively be financing the purchase of private assets as well). On top of all this, the BoJ has forced the yen down by a third against the euro, which will add to deflationary pressures in the euro area.

If this shows any signs of succeeding in Japan, surely there will be irresistible pressure on the ECB to follow suit. If however the BoJ experiment fails, markets may become very sceptical whether there is any escape route from deflation in the euro area.

One final point will be of interest in global markets. If QE works at all, it seems to work mainly by changing expectations about asset prices in the financial markets. In the past, the Fed has always been assumed to be the dominant actor in changing market expectations. Now, the Fed is contemplating tightening policy while other central banks are stepping up QE.

The bullish response of global markets to the opposing Fed/BoJ announcements last week suggests that investors are no longer just slavishly following the Fed.