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Financial Report Bank of Japan 2017

The Bank Of Japan Financial System Report

The Bank of Japan publishes the Financial System Report twice a year in order to assess the stability of the Japanese financial system and facilitate communication with interested parties who are concerned about such stability. The bank provides a regular and comprehensive assessment of the financial system with emphasis on detailing the structure of the system and the policies taken to achieve a robust system.

The bank uses the results of the report to plan the policy to be followed, ensuring the stability of the financial system and provide guidelines and warnings to financial institutions. The bank uses the results of international regulation and supervisory discussions.

In the April 2017 report, the bank reported a notable rise in the prices of the main stock indices and interest rates after the election of the new president of the United States. In Japan, there was also a rise in the stock market and the Yen depreciated. The bank continued with its policy of Quantitative and Qualitative Monetary Easing with Yield Curve Control

The internal loans of the financial institutions in circulation had increased close to 3% annually. There were no signs of overheating in the activity of the financial system nor the real estate market. In general, the financial system had maintained good stability since the crisis of 2008. The capital ratios required by financial institutions were above the level requested by the central bank and had sufficient capital for the risk to which they were exposed.

The results of the macroeconomic stress test indicated that financial institutions as a whole could be considered strong and resistant to economic stress situations. Developments in profits and capital of each institution in these situations of stress varied showing more robust institutions than others.

For the bank, the rise in the US stock market reflected better expectations of the economy and the administration of the new government. As a result of these better expectations about the United States, the dollar appreciated against the major currencies of the world.

In terms of the European financial markets, the stock market had maintained a good general performance coupled with low volatility. The most volatile period of the last two years occurred after the referendum of U.K.

Regarding the monetary policy of the Japanese central bank, the short-term interest rate remained close to 0% or in negative territory. The yields of the Japanese Government Bonds (JGB) continued to show a normal behaviour with the guidelines of market operations where the interest rate had been set at -0.1% and the target on yields on 10-year bonds was 0%. In the following graph, you can see how the yield curve of the JGB was.

Graph 82. Long-Term JGB yields (10 years) and JGB yield curve. Retrieved 5th March 2018 from https://www.boj.or.jp/en/research/brp/fsr/data/fsr170419a.pdf https://www.boj.or.jp/en/research/brp/fsr/data/fsr170419a.pdf

 

As for the Japanese stock market, it had shown an upward trend thanks to the good global performance of the shares, mainly in Europe and the United States. Since the end of 2016 and in 2017, the Japanese index had shown a stable behaviour without major changes.

The amount of credit risk of the main financial institutions had shown a downward trend. This was the result of improving the quality of the loans, which reflected a better dynamic of the economy in general. The following graph shows the decreasing trend of the risk of the main banking institutions.

Graph 83. Credit risk among financial institutions. Retrieved 5th March 2018 from https://www.boj.or.jp/en/research/brp/fsr/data/fsr170419a.pdf

 

In the second report of the year in October 2017, the bank noted that global volatility in the main financial markets remained low, along with positive but moderate economic growth, despite geopolitical tensions with North Korea and the United States. There were no significant changes in capital flows including flows destined for emerging markets.

In Japan, the monetary policy followed an accommodative path and the trend of loans granted had slowed due to a higher cost of loans in foreign currencies. Regarding the local financial market, the rate of growth of loans grew to 3%, and the demand for loans by small companies had improved.

The bank did not observe any financial imbalance in the assets and the financial entities. They continued using accommodative policies granting loans without major restrictions to the economy.

The real estate market showed no signs of overheating, but there was evidence of high prices in some places in Tokyo. In the stress scenarios applied by the central bank, if the financial market faced complex situations and the risk spread to the real economy, this could affect the real estate market.

The bank also did not observe greater imbalances in financial institutions or economic activity, so most commercial banks had good ratios between debt and capital, which made them resistant to stress situations as in the first delivery of 2017. The banks were robust in capital and liquidity regardless of the scenario in which the economy was located, due to a good rebalancing of the portfolios of the banks that have faced a greater demand for loans.

The benefits of Japanese banks have been decreasing, but this is happening at a general level in developed economies due to an environment of low-interest rates which was implemented by banks after the 2008 crisis. In Japan, they have also seen a decrease in the margins of profit of the banks due to the high competition between banks by the market, and in recent years have seen more exits of the market than entries of new banks.

A significant risk that the bank observed was the continuation of low-interest rates in the main economies in the world, which led to greater liquidity in the markets and investors taking more risk than desired by the bank’s board. Given the above, stocks in the United States and Europe had reached record highs, and valuation indicators P/E (Price/Earnings ratio) had reached historically high levels.

As in the April report, the volatility of the financial markets was low, which could mean an excess of market confidence at current valuations and an excessive risk taken by investors, coupled with greater investor leverage.  All this generated a greater risk than desired by the bank’s committee.

In terms of financial markets, the short and long-term interest rates remained stable as programmed by the monetary easing policy and share prices had risen moderately. The short-term interest rate remained in negative territory.

The Yen had depreciated against the Euro reflecting a decrease in uncertainties concerning political situations in Europe, and expectations of a reduction in the monetary policy of the European Central Bank (ECB). On the other hand, the Yen remained stable against the Dollar since the second half of 2017 and some investors expected an appreciation against the Dollar due to some political risks in the United States.

Finally, in the bank’s report, the committee stated that financial institutions had continued to increase their balance sheets reflecting an increase in deposits and the rebalancing of portfolios including risky assets. Assets and total debts of financial institutions increased to 236 trillion yen since 2012, and the portfolio was continuously balanced between bonds and shares.

In conclusion, with the reports issued in 2017 by the Bank of Japan, the financial system was resistant to stress situations tested by the bank, although as in most countries there are banks with better asset quality and portfolios, there are always recommendations for some specific banks. The economy grew moderately during 2017, and monetary policy remained accommodative to encourage banks to grant more loans and thus generate more growth which in the medium term would lead to inflation at 2%.

As mentioned previously, the bank saw some risks in international markets due to a euphoria unleashed, mainly in the stock markets, which could generate imbalances in the real estate sector of the economy. Regarding the Yen with respect to other currencies, the behaviour was stable during the year, although there were slight depreciations concerning the Euro and the Dollar.

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Japan’s Economic Outlook

Japan’s economic outlook

Category: Fundamental analysis, Intermediate, Currencies, economic cycles, Monetary Policy, Economy, Macroeconomics, Central Banks.

Key Words: Central Banks, Monetary Policy, Bank of Japan, Projections.

At each meeting of the bank’s board, a review is made of the state of the Japanese economy, the projections for the current year and the next two years, and the risks to which the economy is exposed both internally and externally.

In the April 2017 report, the board concluded that the economy would continue its positive trend growing above the potential stipulated by the bank, due to better internal financial conditions, some government stimulus and greater global economic growth. The bank was explicit that the expected growth in 2017 and 2018 would be higher than in 2019 due to a cyclical slowdown in fixed investment in business and an increase in the consumption tax that had already been programmed.

As global growth had generally improved, Japanese exports had shown an upward trend, contributing to economic growth. Private consumption had also been resilient due to a better outlook in the labour market with better employment rates and higher wages.

As already mentioned, the bank expected that by 2019 the local economy would slow down a little due to a slowdown in domestic demand reflecting the closing of the cycle of expansion in business investment in addition to the increase in consumption tax since that year.

Regarding inflation, the annual change in the CPI (Consumer Price Index) excluding fresh food continued to show better figures than in 2016 with a clear upward trend thanks to a better performance of the economy and an increase in expectations medium and long term. But even the price growth is not as strong as the bank would like so they followed the price index with some caution.

The annual CPI for April excluding food and energy was close to 0%, so the bank was still expectant that the price index was far from the target rate of 2%.

Regarding monetary policy, the bank indicated that it would continue to apply Quantitative and Qualitative Monetary Easing with the Yield Curve control, with the objective of using it until inflation hit 2% so that the short-term interest rate would remain in negative territory.

Inflation could reach 2% in the medium and long-term, but not in the short term due to the weak behaviour of the main price indices. It was estimated that in the medium and long term it could reach  2% due to better economic growth rates added to energy prices that have been rising in recent years. In addition, the policy of monetary easing continued to drive the supply of credit and liquidity to the market so that inflation continued to rise to the bank’s target figure.

Also, the unemployment rate continued to decrease showing figures between 2.5 and 3%, so the labour market was narrowing which could generate an increase in the nominal wages of people, which in turn could lead people to consume more and this would boost inflation. The following two graphs show the main projections of the members of the committee and the expected behaviour of the CPI until 2019.

Graph 77. Forecasts of the majority of Policy Board Members. Retrieved 27th February 2018 from https://www.boj.or.jp/en/mopo/outlook/gor1704b.pdf

 

 Graph 78. CPI (ALL ITEMS LESS FRESH FOOD. Retrieved 27th February 2018 from https://www.boj.or.jp/en/mopo/outlook/gor1704b.pdf

 

In the July report, the committee stated that the path of economic growth was still positive due to the already exposed factors of a better global panorama and incentives created by the government to stimulate the local economy.

Regarding inflation, there were negative signals that showed a weak CPI (excluding food and energy prices), being in figures between 0 and 0.5%. The bank indicated that it could be due to the caution that the companies had at the time of fixing the prices and the wages of their workers. This behaviour of the companies caused expectations to decrease somewhat on inflation in the medium and long-term. The bank stressed that for inflation to reach 2% companies had to be more determined when setting prices and wages.

What was driving inflation in recent months were energy prices due to higher global demand for fuels and the agreements reached by OPEC to sustain oil prices, which is why the bank was concerned that the other components of the prices were not contributing to the rise of the recent CPI.

Due to the weakness of inflation, the bank decided that it would continue with its policy of monetary easing until inflation was close to levels close to 2%, so that short and medium-term interest rates would remain in negative territory. In addition, the financial market continued to offer credit facilities to the market.

Despite the weak performance, in the bank’s projections, it was estimated that in the medium and long-term the inflation rate would be at 2%, but the projections had fallen slightly on this variable for the next two years.

In the October 2017 report, the bank’s committee continued to observe a positive performance of the economy due to higher exports thanks to the better performance of the world economy throughout 2017.

In terms of domestic demand, fixed investment in business had followed a slight upward trend with better profits from companies and better expectations of entrepreneurs on the Japanese economy.

Private consumption continued to grow moderately, thanks to the better performance of the labour market. There were good rates of job creation and wages rose slightly. Public investment had also had positive behaviour during the last quarter, but not spending by households that had shown flat figures throughout the year.

Looking at the financial conditions, the outlook did not change with respect to the two previously issued reports, since the short and medium-term rates remained in negative territory. Financial institutions were still willing to lend to the market, and corporate bonds were still well received by the market, so the bank continued to observe the accommodative financial conditions.

Although inflation continued to rise slightly as in mid-2017, this behaviour was mainly explained by the rise in fuel prices and energy in general. The weak behaviour of the CPI excluding food and energy was due to the little increase in prices of companies as well as wages and a mobile phone market increasingly competitive in prices.

If you compare the projections that the bank had in October with the projections at the beginning of 2017, the CPI showed a weaker than expected behaviour, but it was expected that in 2018 and 2019 inflation would have more positive figures as shown in the following graph.

Graph 79, CPI (ALL ITEMS LESS FRESH FOOD, Retrieved 27th February 2018 from https://www.boj.or.jp/en/mopo/outlook/gor1710b.pdf

 

The reasons for a better performance of the CPI for the following years should be given thanks to better conditions in the labour market, better performance of the economy in general and better market expectations. The graph shows that inflation bottomed out at the end of 2016, showing deflationary signs.

The risks faced by the Japanese economy according to the bank were:

  • New regulations implemented in the United States and economic performance will directly affect global growth
  • Geopolitical risks
  • The Brexit negotiations
  • The problem of the European debt

These factors could affect the decline of the Japanese economy due to its direct involvement in world trade. The following graph shows the bank’s projections at the October meeting.

Graph 80. Forecasts of the majority of Policy Board members. Retrieved 27th February 2018 from https://www.boj.or.jp/en/mopo/outlook/gor1710b.pdf

 

If these projections are compared with those made at the beginning of the year and July, expectations for 2017 and 2018 improved and remained the same for 2019. That shows the good performance of the economy and a slight recovery of inflation, but as the bank reaffirmed that recovery was not robust since it was mainly based on energy prices. The other components of the CPI did not yet show positive figures, so the bank expected 2019 to be close to 2%.

As long as the inflation rate was not close to 2%, the monetary easing policy would continue. That would include negative interest rates and acquisitions, and corporate bonds to provide liquidity to the market and thus achieve better growth rates. This would encourage companies to be more aggressive in its increases in prices and wages of workers, which was not as strong as would be expected from a narrow labour market, although they did rise during 2017.

The following graph shows the CPI excluding food and energy which shows that the figure during 2017 was well below 0.5% which is negative and gives the reason why the bank committee was concerned because the basic items of the index showed a very weak behaviour.

 

Graph 81. Chart 38, CPI. Retrieved 27th February 2018 from https://www.boj.or.jp/en/mopo/outlook/gor1710b.pdf

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