BoJ: Rate cut not in the cards, except in the event of a significant Yen appreciation
After revealing the policy assessment last month, the Bank of Japan (BoJ) will make the first monetary policy decision on April 27th. Based on the evaluation, the BoJ prepared itself to cut the policy rate further by introducing a new loan. This scheme provides larger incentives to lend with a lower policy rate, which is intended to protect banks’ profitability from a further rate cut. Therefore, the important question for financial market participants is whether the BoJ will actually cut the policy rate or not, as hinted by Governor Kuroda.
While the possibility of a lower policy rate has increased, we believe the BoJ will remain very cautious in deciding whether to cut rates further. To be sure, a lower policy rate would increase the incentive on the BoJ’s new scheme with an outstanding amount of JPY 125 tr. However, from a market mechanism, a further rate cut will arguably lower the lending rate for most of bank loans amounting to JPY 587 tr (Chart 1). Therefore, the net effect of a rate cut is a reduction in banks’ profitability in as far as it will further reduce banks’ net interest margin and it might not lift the demand for loans.
Furthermore, deflationary pressures are receding gradually, on the back of a technical recovery and higher commodity prices. Supported by strong export demand from China, a smaller output gap is expected to put some upward -even if moderate – upward pressure on prices. These developments are expected to raise the CPI inflation from 0.0% YoY in 2020 to +0.3% YoY in 2021 and to +0.6% YoY in 2022.
Therefore, although the BoJ recently introduced a new loan scheme enabling further rate cuts, the Bank is unlikely to lower the policy rate any time soon, all the more so since we are not expecting renewed deflationary pressures. A stronger Yen below USDJPY=100 could change this scenario as it would indeed create new deflationary pressure through lower import prices.
Even if we do not expect a new rate cut, at least, Governor Kuroda can use the new policy tool as a way to protect the interest margin and also remind market participants of the risks of a too strong yen.
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