Battle weary

BoJ credibility frayed by oil and Swiss surprise

The Bank of Japan (BoJ)'s credibility is looking frayed. Cheap oil is partly to blame. But last week's Swiss shock has added a further complication. The Swiss National Bank (SNB)'s surprise capitulation to deflation has made investors question how much more BoJ Governor Haruhiko Kuroda will - or can - do to boost inflation.

Japan's monetary authority on January 21 slashed its inflation forecast for the financial year ending March 2016 to 1 per cent, from a previous prediction of 1.7 per cent. The BoJ also promised more cheap loans to banks. But it refrained from tinkering with its main anti-deflation toolkit: expanding its balance sheet by sucking up Japanese government bonds.

The BoJ's holdings of government securities have grown by 40 per cent to 255 trillion yen ($2.2 trillion) over the past year. On current plans, the central bank could end up owning 40 per cent of all outstanding JGBs by early 2017. Yet all this yen-printing is looking powerless when it comes to pushing inflation nearer to the central bank's 2 per cent target.

Repeatedly missing its aim would undermine the central bank's credibility. And that's quite possible if falling energy costs weaken workers' bargaining power in ongoing wage negotiations. Subdued household incomes could mean that the prices of goods and services slide again, cementing expectations of further declines.

Then there is the Swiss effect. The SNB's surprise decision to scrap its exchange-rate ceiling on the Swiss franc has given investors another reason to doubt Kuroda's determination to keep up the fight against deflation. The Japanese bond market now does not expect inflation to hit 1 per cent until mid-2018.

In October, Kuroda barely succeeded in persuading others on the BoJ policy board to support additional easing. If he tries to adopt new moves, he might fail. This week, the yield on the five-year bond turned negative, which raises concerns about future financial stability.

Kuroda's choices are grim: reaching into his depleting arsenal again would show he isn't walking away from what's beginning to look like an impossible fight. But if he does fire another bullet, investors might just conclude that he has used up his last one.