Bank of Japan Puts the Pedal to the Metal With New Easing

A decade after Federal Reserve Chairman Ben Bernanke travelled to Japan and preached the benefits of reflationary policy to the Bank of Japan, it finally seems as though leaders at the Bank of Japan are heeding his call. With the latest moves overnight, the Bank of Japan, led by Governor Haruhiko Kuroda, has announced staunch new easing policies aimed at reflating the economy.

The Bank of Japan is clearly backing up the rhetoric of the past 6 months with new easing measures. First of all, the Bank of Japan is set to increase asset purchases to 7 trillion yen, or more than $73 billion, per month in bonds and will increase the monetary base some 50 percent by this time next year and expects to double bond holdings in two years. For comparison, the most the Fed has increased the monetary base in one year is about 20 percent.

However, asset purchases are just one of the many policy tools announced overnight. The Bank of Japan first has announced that it will extend the average maturities of its bond holdings to seven years from three years, giving it the leeway to purchase longer dated bonds. Also, the Bank of Japan is switching its policy target from to the size of the monetary base from targeting an overnight borrowing rate, a very strong indication that easing efforts will be strong.

The Bank of Japan also announced that it will merge its two asset purchase programs into the quantitative easing to make purchases more clear to markets. The Bank followed this by announcing that it is temporarily suspending the Bank Note Rule, with a view to permanently suspend the rule, and also announced that QE will continue until inflation reaches 2 percent, ideally in 2 years time.

For reference, the Bank Note Rule was a self-imposed rule on the Bank of Japan upon its creation to make sure that the BoJ's balance sheet did not become over-leveraged. Effectively, the rule limits the amount of bonds the BoJ can hold to the amount of currency in circulation. However, by abolishing the rule, the BoJ can effectively lever itself up and buy more bonds.

The news was obviously expected by markets but nevertheless was a strong signal that the Bank of Japan is finally ready to do what it must to tackle deflation and spur growth in the Asian economy. The new combined efforts at the Bank of Japan seem like enough to reflate the economy, but no one will know how successful the BoJ has been in its efforts for some time. A key indication that the BoJ is becoming effective would be to see inflation creep higher and industry services turn more positive.

Markets saw seismic shifts on the news, especially the yen markets. The Japanese Nikkei Index rose 2.2 percent and the broader TOPIX Index gained a strong 2.7 percent, both moves following near 3 percent gains Wednesday. The yen declined massively against all major pairs also overnight, dropping 2.59 percent against the dollar as the USD/JPY rose to 95.45. Also, the AUD/JPY rose 2.14 percent to 99.441 and the EUR/JPY gained 2.28 percent to 122.27.

Also, gold priced in yen saw a sharp spike overnight. The XAU/JPY cross popped 1.76 percent overnight to 147,505.1875 yen and is now up over 18 percent over the past year priced in yen. The move in gold priced in yen is just another sign of the BoJ's efforts taking fruit.