Month: February 2010

Bank of Japan policy board member Seiji Nakamura rebuffed government pressure for more BOJ action to fight deflation, saying that pumping liquidity into the financial system alone will not put an end to debilitating price falls.

The heavily indebted government fears deflation and a strong yen could push Japan back into recession in the run-up to upper house elections. Analysts say it may urge the central bank to buy more government debt or expand a funding operation it introduced in December to prevent that.

Nakamura suggested the bank wasn’t likely to oblige by increasing its debt buying, however, warning the government that it needs to get to grips with its fiscal problems.

“The economic recovery has shed light on fiscal discipline,” he told a news conference after giving a speech to business leaders in Fukuoka in southwest Japan.

“It would be a grave issue if yields rose because of a risk premium or investor fears over the risk of holding government bonds. The government needs to tackle the issue before the markets start moving,” he said.

The prime minister and finance minister have been calling on the central bank to do more to help ease deflation, but they haven’t said exactly what steps they want the BOJ to take.

“Nakamura is resisting government pressure and asserting the BOJ’s independence,” said David Cohen, director of Asian economic forecasting at Action Economics in Singapore.

“The BOJ tried quantitative easing a few years ago and didn’t enjoy much success. This also highlights its impotence.”

The BOJ is reluctant to ease monetary policy further partly because it expects the pace of falls in prices to ease gradually. Last week it said deflation would be milder than it previously forecast in the fiscal year from April and the following year.

Pushing back
Nakamura said the fight against deflation, where price falls and weak demand feed into each other as buyers wait for prices to slip even further, must be shared.

“In order to solve demand shortages, it is important for the BOJ, the government and private sector firms each to play their own role,” he told business leaders.

He stressed the need for innovation in the private sector for creating demand, but offered few other clues on what fiscal or monetary policy options there were to get prices rising.

For its part, the government, whose support rate is slipping ahead of upper house elections due in summer, has little room to lift demand by spending more as the national debt is already nearing 200 percent of GDP.

Standard & Poor’s last month cut the outlook on Japan’s AA debt rating to negative, saying the policy bind could lead to a downgrade unless measures were taken to stem fiscal and deflationary pressure.

“It is natural for central bank policymakers to call for fiscal reconstruction when debate about exit strategies globally is focusing more on fiscal issues than monetary policy,” said Masamichi Adachi, senior economist at JPMorgan Securities Japan.

The BOJ is virtually alone in expanding monetary easing. The Federal Reserve and the European Central Bank have said they will start phasing out their emergency lending and liquidity facilities in light of improvements in credit markets.

“The government and the BOJ need to talk to each other more about the fiscal problem, but that hasn’t happened in Japan so far,” Adachi said.

The Japanese economy started to recover from the second quarter of last year and it is expected to post fairly robust growth for the fourth quarter.

But Nakamura said the downside risks were still larger than those on the upside and that the bank won’t rule out any policy options in responding to economic conditions ahead.

Most economists think the economy will slow down in the first half of 2010 and, as the recovery is driven mostly by strong exports to Asia, it could be hurt by any further rise in the yen.

Nakamura said strong demand in Asia may cause Japanese firms to shift production abroad, thus limiting a recovery in domestic capital spending and jobs even as the overseas economy recovers.

Ireland’s services sector shrank by its fastest rate in six months in January, when a marked fall in new orders indicated that unusually bad weather was not solely to blame, a survey showed this week.

The NCB Purchasing Managers’ Index fell to 44.4 from 48.3 in December, when it had reached a level last equalled in February 2008 and begun to close in on the 50 mark that separates growth from contraction.

The sub-index measuring new business slipped to 45.5 from 48.7 in the previous month, retreating to its lowest level since September last year.

“Worryingly the level of new orders fell back sharply, highlighting that this was more than just weather-related problems,” said Brian Devine, economist at NCB Stockbrokers, commenting on the services PMI data.

“The latest data highlight how fragile domestic demand is in the Irish economy.”

Markit, which compiles the data, said anecdotal evidence suggested that poor economic conditions were largely responsible for the latest reduction in the headline figure.

However, despite most sub-indexes continuing to contract in January, new export orders increased for the fifth successive month, albeit at the slowest rate in that sequence.

Another PMI survey on Monday showed a similar pattern, with orders from abroad in Ireland’s manufacturing sector accelerating to their highest level since October 2007 although the headline PMI index worsened at a faster month-on-month rate.

“New export orders increasing for the fifth month in a row highlights the dichotomy between the domestic Irish economy and the global economic recovery,” NCB’s Devine added.

Australia’s central bank shocked markets by skipping an interest rate rise this week, citing the impact of higher mortgage rates at home while noting tighter policy in China and concerns over sovereign debt abroad.

The Reserve Bank of Australia’s (RBA) decision to keep its key cash rate at 3.75 percent confounded expectations of a rise to four percent and hammered the local currency as investors slashed estimates for how high rates might go this year.

Yet, RBA Governor Glenn Stevens also emphasised that, should the domestic economy continue to improve as expected, then further hikes would likely be needed over time.

“This is a pause, not a stop,” said Peter Jolly, head of research at National Australia Bank. “It’s just that they paused earlier than most thought.”

“I don’t think they have radically changed their view,” he added. “We still think they need to lift rates again and we see rates at 4.75 percent by the year end.”

The market was badly caught out, however, having almost fully priced in a hike at the policy meeting.

Investors now doubted if the RBA would move in March either, with futures pricing in around 35 percent chance of a rise. Expectations for the next 12 months were pared back to show around 80 basis points of tightening, compared to 105 basis points before the announcement.

“It implies that the RBA feels it has done enough for the time being,” said Stephen Roberts, a senior economist at Nomura. “You’d think there would be a pause for a few months before lifting to four percent by mid-year. It’s going to be a slow process getting the cash rate higher.”

One eye offshore
The RBA’s caution was warmly welcomed by the Labor government which faces a tough election fight later this year.

“Families will welcome this decision and businesses will welcome this decision,” Treasurer Wayne Swan told parliament. Mortgage rates are a sensitive topic in Australia, where home ownership is a national obsession.

Analysts suspected recent events offshore may have added to the case for a pause. In a brief policy statement, RBA chief Stevens noted China had begun to rein back stimulus in its economy, global credit conditions were difficult and worries had grown over debt levels in some countries.

China’s tightening have rattled investors globally as they worried demand from the world’s major growth engine could falter. South Korea’s finance minister told reporters last week that the government needed to prepare to offset the impact of any policy moves in its biggest export market.

“So maybe a little bit more of international concern stayed their hand and they want to see how that evolves,” said Joshua Williamson, an economist at Citi.

“But there is a risk given the underlying strength of the (domestic) economy that this was a missed opportunity and they’re going to have to potentially go a little harder in the second half of the year if they don’t make this up in the next few months.”

Indeed, the RBA was resoundingly upbeat on the domestic outlook saying the economy had proved stronger than expected with unemployment peaking much lower than feared, resource investment strong and house prices up sharply.

The source of doubt seemed to be that lending rates in the economy had risen faster than the cash rate, as banks sought to cover increased funding costs caused by the global credit crisis.

The RBA has estimated that effective rates across the economy were now more than 100 basis points above the cash rate, far higher than before the credit squeeze.

This means that a neutral rate, one that neither stimulates nor retards economic growth, is also lower than in the past.

As governor Stevens often says when quized on where neutral is: “We’ll know when we get there.”