191003 japan revision to our forecasts

Japan Watch

Group Economics

03 October 2016

Revision to our forecasts • Maritza Cabezas Senior Economist Tel: +31 20 343 5618

•

maritza.cabezas@nl.abnamro.com Roy Teo

• •

Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com

•

We think that the BoJ’s new policy framework sets the stage for further easing to back up its inflation commitment However, given the BoJ is more cautious stance, we no longer expect a rate cut this year We expect the BoJ to cut policy rates by 10bp to -0.2% in 2017 We think that delaying stimulus will result in lower inflation than we had initially projected. Our inflation forecast is now -0.2% for 2016 (was -0.1%) and it remains 1% in 2017.

USD/JPY range in 2016: 100-104; 110 in 2017

Yield curve control vs more stimulus…

On 21 September, the BoJ fine-tuned monetary policy, but did not expand stimulus and kept QE purchases and negative rates on hold. The BoJ also announced that it will continue expanding the monetary base until the year on year rate of increase in the core inflation exceeds the price stability target of 2% and stays above it in a stable manner. We think that there are three main reasons for the recent policy announcement: First, it gives the BoJ time to evaluate the effectiveness of the measures taken earlier this year, particularly negative rates; second by targeting 10y yields at 0% it reduces the impact of negative rates for the financial system; and finally this cautious approach cools down expectations for additional easing, which was considered highly likely until recently. …unlikely to boost inflation expectations We are sceptical that the BoJ’s recent measures will revive the economy. We think that the BoJ will have to control the yield curve for some time before growth starts picking up.

In the short run, the recent measures will mainly give support to the financial system as higher medium and long term interest rates will increase bank’s interest income and profits. However, we do not expect this to be meaningful. One of the reasons is that the duration of banks’ bond holdings is around 3-5 years and loan duration is 3-4 years.

Moreover, it seems that a weaker JPY would be more positive for banks’ profits. On top of this we think that this framework is unlikely to boost inflation expectations materially as the BoJ’s JGB purchases may fluctuate either upward or downward to achieve the target level of long term interest rates (which may be changed in subsequent monetary policy assessments).

Insights.abnamro.nl/en

2 Japan Wattch – Revisiion to our fo orecasts- 03 3 October 20 016

Negative rates mos st effective opttion for easing g e BoJ has beco ome more cauttious in easing to ensure the We conclude that the sustain nability of policcy. However we e still think that the BoJ needss to do more. We W also think th hat cutting the negative rate further f remains s the BoJ’s ma in option for future easing going forward f (notwitthstanding pote ential changes in their yield ccurve target). The BoJ has explicitly mentioned tthe possible op ptions for furthe er easing in its most recent communication. More eover, Governo or Kuroda has said that negaative rates can be effective in supp porting a weakker yen. Howev ver, the BoJ seems to have noo urgency. The eir assess sment is that a bout 50% of th he deviation in inflation is duee to a decline in n crude oil prices.. Hence the Bo oJ is taking its time t to evaluate previous poliicy measures and a the impactt of the new po olicy framework k in combination with QQE. T This will also giv ve banks time to o adjust their bu usiness models to the prospe ects of lower raates by bolstering non interes st rate income.

Chang ges in our fore ecasts We no ow no longer exxpect further ra ate cuts this year. However giiven the BoJ’s commitment to overshoot the infla ation target we think that in 20 017 the centrall bank will anno ounce one rate cu ut (-0.20%). Ou ur assessment is that a combination of furthher rate cuts, fis scal stimulus that is supportive to g growth and stru uctural reforms s which reducee the impact of an aging popula ation, including reforms in the e labour markett, will be more eeffective in sup pporting the economy. We mainta ain our GDP forecast this yea ar at 0.6% in 20016. We see so ome upside o growth resultting from some ewhat stronger external demaand, particularly y from risks to China.. Inflation, howe ever, should ed dge down furth her to -0.2% in 2016 from 0.1% previously. In 2017 w we maintain ou ur GDP growth forecast of 0.77% and inflation of 1%. cations for US D/JPY Implic We do o not see any m material reason n to change ourr forecasts for tthe JPY becau use we see offsetting factors. On n the one hand, we have chan nged our view oon the BoJ. We e no longer i negative te erritory. This shhould give support to the expectt the BoJ to cutt rates further into yen as s financial markkets still partly anticipate a rate reduction. O On the other ha and, we expectt investor senti ment on global financial mark kets to remain relatively cons structive and this sh hould result in lo ow demand for the yen from a safe-haven ppoint of view. Therefore, T USD/J JPY has some upward bias.

A policy rate cu ut this year is s less likely

Firmerr oil prices sh hould raise in nflation expec ctations

%

USD/barrel

Bps

0.2

1.4

0.0

1.0

-0.2

0.6

120 100 80 60

-0.4

0.2

-0.6 Jan-15

Ma ay-15

3mth T-billls

Sou urce: Bloomberg

Sep-15 Policy rate %

Jan-16

May-16

Sep-16 6

JPY OIS im mplied policy rate

40

-0.2 Jan-14

20 Jul-14

J Jan-15

Jul-15

5y5y JP inflattion swap (lhs) Source: Bloomberg B

Jan-16

Jul-1 16

Brent crude oil o (rhs)

3 Japan Wattch – Revisiion to our fo orecasts- 03 3 October 20 016

Moreover, we continu ue to expect a Fed rate hike in December w which is for 60% % priced in.

This sh hould result in some apprecia ation of the USD versus the yyen. In addition n, one of the important drivers for yen strength th his year has be een higher reall yields in Japa an versus the US. We W think that thi s move has run its course an nd therefore thee upward mom mentum in the yen will abate. We exxpect USD/JPY Y to trade around 100-104 forr the rest of this year. In 2017, we expect an iimprovement in n risk sentimen nt (as global groowth gathers momentum), m furtherr rate cuts in Ja apan and tighte er monetary po olicy in the US. This is likely to o weigh on the JPY towards 110 0 against the USD.

DIS SCLAIMER This document has been prepared by ABN AMRO O. It is solely intended to provide financial annd general information on economics. The infformation in this docum ment is strictly proprieta ary and is being supp plied to you solely for yyour information. It mayy not (in whole or in parrt) be reproduced, distr tributed or passed to a third party or used for any other purposes thhan stated above. This document is inform mative in nature and d does not constitute an offer o of securities to the e public, nor a solicitatition to make such an offer.

No re eliance may be placed d for any purposes wha atsoever on the informa ation, opinions, forecassts and assumptions co ontained in the docume ent or on its completenness, accuracy or fairness. No repre esentation or warranty,, express or implied, iss given by or on behalf of ABN AMRO, or anyy of its directors, officerrs, agents, affiliates, grroup companies, or em mployees as to the accu uracy or comp pleteness of the inform mation contained in thiss document and no liab bility is accepted for any ny loss, arising, directly y or indirectly, from any y use of such informatioon. The views and opin nions expressed herein may be subject to ch hange at any given tim me and ABN AMRO is under u no obligation to uupdate the information n contained in this docu ument after the date the hereof. oduct of ABN AMRO Ba ank N.V., you should obtain o information on va various financial and oth her risks and any poss sible restrictions that yoou and your investmen nts activities may Before investing in any pro enco ounter under applicable e laws and regulations.. If, after reading this document, d you consideer investing in a produc ct, you are advised to discuss d such an investm ment with your relation nship manager or perso onal advisor and checkk whether the relevant product –considering the risks involved- is aappropriate within your investment activities. The value of your invesstments may fluctuate.. Past performance is no o guarantee for future rreturns. ABN AMRO re eserves the right to mak ke amendments to thiss material. © Co opyright 2016 ABN AM MRO Bank N.V. and affi filiated companies ("AB BN AMRO")