For years the market has been speculating that when the next recession comes that major central banks would have very little fire power left. Few, with the notable exception of the Federal Reserve, had made any real progress in unwinding the rate cuts or the balance sheet expansions that followed the Global Finance Crisis. For their part, central banks maintained that they still had plenty of ammunition left. For credibility reasons there was never any incentive for them to say anything else. The real test of central banks is now upon us and the Bank of Japan, which has been pursuing ‘unconventional’ monetary policies for decades, is at the forefront of criticism that its firepower is limited. In particular there are concerns that the BoJ is facing an uphill battle in persuading the commercial banks to unleash further lending to small and medium sized companies.

SMEs are crucial to the labour market in Japan where they reportedly support around 70% of the country’s workers. The Japanese press reported at the end of last week that the Abe government is working on a plan that will subsidize 100% of the salaries of workers at small firms. It is estimated that this would cover around 10 million furloughed workers. Yesterday’s release of a survey conducted a month ago by the NN Life Insurance Company suggested that nearly 60% of SMEs would be only able to survive the impact of the shutdowns if they were lifted in the next few months. The survey also suggested that 25.2% of SME were already in urgent need of cash at the end of March. For many the impact of the shutdowns has accentuated supply chain disruptions which started last year as a consequence of the China/US trade war. The government’s recently announced stimulus package already included a support fund to help finance local businesses bringing manufacturing back to Japan from China or to move to other countries in the region. The government has also launched zero-rate loans for SMEs and, included into its emergency economic package is the provision for subsidies of up to JPY2 mln for firms suffering a sharp drop in revenue due to the epidemic. Today, as part of its policy response the BoJ offered to pay a positive 0.1% interest rate to financial institutions that tap its new loan programme. This is aimed at encouraging commercial banks to boost lending to cash-strapped firms.

Since 2016 the BoJ has included a yield-curve-control element to its huge QQE policy. This followed wide scale criticism that low rates and the flat yield curve was pressuring the profitability of the commercial banks to the extent that lending was likely to suffer. Today, the BoJ has also announced that it was revising its loose annual limit on bond purchases of Y80 trn, in addition to scaling up the amount of corporate bonds and commercial paper it will purchase. In reality, the BoJ has been buying far less that Y80 trn in its bond purchasing programme, suggesting this news offers no real change in policy. It will, however, allow the BoJ to quietly revert to far smaller levels of bond purchases when the crisis passes.

Compared with other major economies, the significance of the BoJ’s extravagant bond purchasing policy lies with the amount of paper already on its balance sheet. Japan is the most indebted country in the world with a debt/GDP ratio of around 240%. The BoJ holds around 44% of outstanding JGBs. For years, there have been waves of speculation that Japan’s bond bubble will burst and that this will bring a calamitous drop in the value of the JPY.   That said, the market has never come close to questioning the credibility of the BoJ or that of the Abe government. On April 2 S&P reaffirmed Japan’s credit rating outlook as positive adding that “within the next one to two years, Japan will return to a fiscal trajectory that stabilises or improves its government debt level relative to GDP.” It seems that as long as PM Abe does just enough to be seen as following a prudent policy that investor confidence will continue to hold in Japan. That said, the BoJ today estimated that domestic growth will plunge by -5% in FY 2020 and that any hope of gathering momentum on inflation has been lost in the face of the drop in oil prices and on the fall in consumer confidence. This shutdowns look set to undo years of work by both the BoJ and the government to push back on the issues of low growth and disinflationary pressures. If policymakers fail to contain the pressure on the real economy and on employment, there is a risk that the credibility of both will be tested. For now we expect USD/JPY to hold close to current levels on a 3 month view. While the USD has proved itself to be the ‘go-to’ safe haven of many investors over the past couple of months, the JPY is set to remain particularly sensitive to regional news and currently to rumours regarding the health of N. Korea leader Kim Jong Un.