Oil $15 Below Bank of Japan Assumptions Drives New Stimulus Bets

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Falling oil prices are undermining the Bank of Japan’s efforts to spur inflation, threatening to overturn the consensus that policy makers are done with easing.

While BOJ Governor Haruhiko Kuroda has expressed confidence the current level of monetary stimulus can drive inflation to its 2 percent target in 2016, the market is looking less convinced. The gap between the 10-year and two-year Japanese government bond yields has narrowed to 41 basis points, down from 53 two months ago.

While economists see no immediate prospect of expanded stimulus -- the BOJ kept monetary policy unchanged Friday as predicted -- the flattening curve suggests bets it’s coming. The central bank’s inflation forecasts are based on oil prices about $15 a barrel higher than the current benchmark level.

“Declines to below the BOJ’s projected level are now reigniting speculation of additional easing,” said Mari Iwashita, the chief market economist at SMBC Friend Securities Co. in Tokyo.

The benchmark crude price was below $45 a barrel on Friday, more than 50 percent cheaper than a year ago. While that’s been a windfall for Japanese corporate profitability, the impact is evident in the nation’s consumer prices excluding fresh food which rose just 0.1 percent from a year earlier in June. The BOJ has trimmed its inflation forecast to 0.7 percent from 0.8 percent for the year through March 2016 -- based on oil prices at $60-70 per barrel.

Earnings Outperform

A BOJ gauge of corporate earnings for manufacturers rose for a ninth month to June, thanks to falling crude prices. The Input-Output Price Index shows what companies can charge for their products is exceeding input costs, suggesting more of a buffer for profits. Earnings per share, excluding some items, at 226 companies on Japan’s Topix index have beaten analyst estimates while 129 missed for the latest earnings season as of Friday, according to data compiled by Bloomberg.

“The renewed decline in oil prices and the weak yen are buoying corporate earnings at a time when domestic demand remains lacklustre,” Nicholas Spiro, managing director at advisory firm Spiro Sovereign Strategy, wrote in an e-mail on Aug. 3.

West Texas Intermediate crude has fallen from above $107 a barrel in June 2014 and hit a six-year low of $42.03 on March 18.

No Expansion

Twelve of 37 economists surveyed by Bloomberg expect the BOJ to add stimulus at the meeting on Oct. 30, unchanged from last month. Sixteen predict it won’t expand monetary stimulus at all, the most popular answer in the survey conducted July 27-Aug. 3.

That perception that the BOJ won’t step up bond buying caused the benchmark 10-year government bond yield to rise in early July to as much as 35 basis points above the record low 0.195 percent in January. The yield was 0.415 percent in Tokyo on Friday.

While economists say Japan remains on a moderate recovery trend, they point to the risks from the slide in commodities prices and signs of slowdown in Chinese growth.

“Worries about China weigh on commodities demand overall and oil’s weakness reflects a slowdown in the global economy, something the BOJ will need to monitor as downside risks,” said Tsuyoshi Ueno, a senior economist at NLI Research Institute in Tokyo. “Falling oil prices are good for the Japanese economy in the long run and so ultimately bolster inflation, but what’s behind this decline isn’t favorable for Japan.”

Unattainable Target?

Just one economist in the Bloomberg survey said inflation would reach the 2 percent goal around the April-September 2016 window predicted by Kuroda. The median estimates of Japan’s core consumer price index are a 0.6 percent increase for this year and a 1.1 percent gain for 2016, according to a Bloomberg survey of 22 economists.

“If falling oil prices raise concerns about a slowdown in global growth and spark risk aversion, investors can’t sell bonds,” said Makoto Suzuki, a senior bond strategist in Tokyo at Okasan Securities Group Inc. “Yields will steadily tread lower as the BOJ continues to buy.”

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