Will Japan's Surprise Move Start a Currency War with Europe?

The Bank of Japan’s decision to accelerate asset purchases as the Fed is backing off means a strong dollar is likely here to stay, says Morningstar’s Bob Johnson

Jeremy Glaser 4 November, 2014 | 1:46PM
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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We thought the big central bank news this week would be from the FOMC, but it turns out the Bank of Japan surprised markets with a large, new quantitative-easing programme. I'm here with Bob Johnson--he's our director of economic analysis--to look at this programme and see how it could impact Japan and global markets. Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: Let's briefly look at what the Bank of Japan announced. How big is this programme relative to, say, the Fed programs they've had in the past?

Johnson: It's a quantitative-easing programme where they are doing bond-buying, and they've been doing it for some time. I think they are about 19 months into the programme, and they have now expanded that programme by about 33%. So, a pretty big increase in the amount of bonds that they are buying back.

And that would put the programme roughly on scale with where the Federal Reserve's bond purchase programme was at its maximum point. So, it's clearly a big programme. It was already large, but they've just stepped up the game a little bit. And part two of it was--and perhaps offsetting some of that bond-buying--is that one of their large pension funds will now shift into more stocks and less into bonds and that includes domestic Japanese stocks as well as worldwide equity. So, that's certainly got everybody a little bit excited, too. So, they've kind of cut out the middle man where lower rates encourage more stock purchases--they are actually encouraging stock purchases.

Glaser: Why are they pushing the accelerator right now? What has them worried?

Johnson: Great question. And that's why it kind of took everybody by surprise. But what had happened is that there was a big sales tax increase this spring in Japan, which slowed the economy--everybody expected it to. It looked like it was kind of limping back up from that sales tax increase. Sales taxes decrease consumption, tend to depress inflation. Things looked a little better, and then the numbers came out for September and there was no hiding it. It really hasn't gotten much better in reality. Inflation is still way too low, consumption is low, and yet there is another round of sales taxes scheduled to come on. So, that's really got Japanese officials worried.

So, they figured before the deflationary mindset set in that they take firm action to surprise the markets. And it wasn't a full vote. It was split almost down the middle. They barely passed, so there was certainly some controversy relative to the measures.

Glaser: So, what impact will this have on the Japanese economy? Is it enough to really boost inflation?

Johnson: The rates have always been relatively low in Japan. It's a question to me whether it's going to help all that much. It certainly brought in the yen, and that will help in a big way for their exports. It's a relatively big export economy, still. And the yen has deteriorated significantly with all the announcements of these programmes, and that's probably going to be the biggest boost to the economy. Then, some of the stock-buying may create a little bit more of a wealth effect.

There are a lot of savers in Japan. And if you have low interest rates, maybe some of the stock purchases and what those do for their markets over there might increase that wealth effect a little bit. So, I think it will probably help some, but they are fighting some pretty bad demographics right now. Unfortunately, they are pretty heavily indebted, too. It's a bit of a worry. Their economy has always looked like it's on the edge.

Glaser: Looking at the impact on the rest of the world, it seems like the very initial conventional wisdom is that this might help keep rates low across the entire world. Is that what you expect? Do you think that this will keep rates in the U.S. maybe lower than we had expected?

Johnson: Well, that's certainly the interpretation. And it's almost as if we had free money from the Fed for a while, now they're done with their bond-buying and on almost the same day they finished, Japan increases their programme. So, in the end, the liquidity in world markets overall isn't much changed.

So, certainly from that standpoint, it's probably helpful; but one has to keep in mind that Japan's always been a little bit of a separate market. Their rates have always been a little bit lower than everybody else's. And as Japan goes, so doesnot go rest of the world. That's a little bit more difficult of a step to make than it is in a lot of other economies because of the way they have cordoned off some of their economy.

Glaser: With the yen weakening, do you see any risk of, say, a currency war, where the ECB steps in and tries debase the euro? Or maybe the Fed says the dollar can only get so strong. Is that a concern for you?

Johnson: So far, not yet. I do think that the Japanese moves today open the door for Europe to probably do more if they need to. If Japan's going to do it, then that blesses it in a way. And I think, certainly, that opens the door for them to do something more. Whether we have gotten to the point where it's actually war yet, I don't really think so. I think the U.S. Fed continues to kind of tighten up a little bit, and I think we saw that this week.

So, I'm not really worried. The conditions seem to be dictated by the individual countries that we are in. And I think it makes some sense for the Japanese to do it, and it makes some sense for the Europeans. Unfortunately, it's not great news for U.S. exporters, and I don't think the Fed is going to step in with another QE program here to just keep us competitive. I think we need to kind of narrow the gap a little bit.

Glaser: So, investors should be prepared for a stronger dollar and look at how that can impact their holdings.

Johnson: I think we'll definitely have a stronger dollar. We already heard in this earnings season on many calls the impact of a stronger dollar, and I think that's only going to get worse. Unfortunately, it will take a little bit off our GDP. We had a pretty good GDP number this week, partially because of exports. But unfortunately, now with both the euro and the yen being so much weaker, that's going to make it a little bit harder on our exports going forward.

Glaser: Bob, I appreciate your take on this today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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Jeremy Glaser  is markets editor for Morningstar.com, the sister site of Morningstar.co.uk.