The Bank of Japan (BoJ) is openly admitting that the economic situation will get worse before it gets better. Board member, Koji Ishida, remains adamant that growth will be seen before the end of this year, but publicly acknowledged that Q2 will be a “volatile” quarter. This is primarily related to a move to increase the sales tax in Japan from 5% to 8% on the 1st April this year. Consumers are rushing to purchase large ticket items such as cars and major household goods ahead of the tax hike. Obviously subsequent to this tax increase there is a difficulty in projecting the fall off in domestic demand and this is what is prompting the central bank to warn of the uncertain economic consequences next quarter.
Ishida’s statement is the beginning of an attempt by the BoJ to re-assure the markets that the impending economic blip is a normal part of the recovery strategy. Expanding on this he was noted as saying that the BoJ would not be reacting to any short-term events affecting the Japanese economy. Markets are interpreting this as a signal that the central bank will not now increase it’s stimulus efforts in order to smooth out the impact of the sudden jump in consumer prices.
Japanese authorities are making serious efforts to kick-start the languishing economy after 15 years of deflation. The stated goal of the BoJ is to raise the inflation rate to 2% by the end of this year. The sales tax hike is a difficult but ultimately valid part of this strategy. Higher consumer prices no doubt contribute to a rising inflation rate. The problem arises when these higher prices choke demand, therefore in order to successfully counter the negative effects of a sales tax increase other economic stimuli must be introduced.
Yesterday’s statement by Ishida would indicate that the Bank of Japan appears to have chosen rhetoric as its stimulus on this occasion. This is a risky strategy that requires somewhat of a leap of faith from the markets. So far this seems to be working, the Yen underwent a very minor selloff following the central banker’s comments, but nothing to cause significant concern. And, should things falter then it is worth bearing in mind that the BoJ can still row back on the rhetoric and introduce actual monetary stimulus if required.
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