Fed Cycle Will Pressure BOJ to Tweak Again: Pantheon's Beamish

(Bloomberg) -- The Bank of Japan will need to adjust policy again if the Federal Reserve’s interest rate hiking cycle turns out to be more aggressive than expected, according to Freya Beamish, chief Asia economist at Pantheon Macroeconomics Ltd.

The Japanese central bank in July announced the most significant policy changes in two years when it said it would let 10-year bond yields move in a slightly wider range. It also cut the amount of commercial bank reserves subject to its negative interest rate and introduced forward guidance, saying it would keep interest rates extremely low for “an extended period of time.”

The most likely next step for the BOJ will be to hike the 10-year yield target by 20 basis points to 0.2 percent, Beamish said.

Beamish analyzes Asian economies from Newcastle, Northern England, a former coal and steel hub that can offer lessons on how to transition to a more diversified economy.

The following are lightly edited excerpts of an exchange conducted by email:

What’s it like to cover Asia from Newcastle, England?

I find it a useful vantage point. Policy narrative is very strong in many Asian countries so having some space allows you to look at the data without getting swept along by the spin … hopefully!

Are there parallels in Britain to what China is going through?

If Britain’s experience offers any insights, it is that the authorities have to cede control and allow capital to flow to where it will be more productively employed. The Chinese authorities have recognized that they must transition away from old-guard debt-laden industries, but I fear that they have learned the wrong lessons from the debacle of Russian privatizations. China’s political presence in business decisions seems to be as strong as ever, if not strengthening. I fear that when push comes to shove they will choose to keep on with wasteful investment, rather than support private consumption through boosting household returns on wealth with greater dividends.

Why do you think China has limited capacity for fiscal stimulus?

The government’s scope to ramp up fiscal stimulus to help cushion the transition is limited by the disappearance of the current-account surplus. The authorities would need to rely on net capital inflows from abroad to finance that. That is a remarkable situation for a country with nearly 50 percent of GDP in savings, and points to still-large amounts of wasteful investment. Something has to correct and we’ve started to see that with the renminbi.

On Japan, do you expect further policy tweaks from the BOJ?

I think the BOJ hasn’t done enough yet to reduce the incentive for financial institutions to engage in risky foreign activities. Reports since the July meeting suggest that it was a compromise. The strong second-quarter GDP rebound, combined with the jump in wage growth, should convince enough minds to back an outright hike in the fourth quarter. The Fed also is likely to turn more hawkish around then; this will increase the pressure on the BOJ to hike as policy divergence has been a key source of financial distortions.

At the moment, the most likely action is to hike the 10-year [yield target] by 20 basis points, though they could come up with another adjustment with an aim to center the yield at around 20 basis points [without raising the official target]. In addition, the Fed’s policy path next year is going to have to be more aggressive than markets are expecting. If that pans out, the BOJ will have to hike again, so as not to fall too far behind.

What’s your outlook for China?

I see a positive tail risk in the next few years that things get so bad that the authorities are forced into properly recapitalizing the financial system in a TARP-like operation. This global cycle is different. In this cycle, China has had to bear the burden of its own excess savings as the overvaluation of the renminbi has prevented the economy from exporting its financial surpluses. In short, they have had to run internal deficits. These are the imbalances that cause recessions, and that is why in this cycle China is slowing first, ahead of the U.S. If the Fed stays the course, this will tighten global liquidity and raise global rates. China is now the economy that is exposed to that.

To contact the reporter on this story: Enda Curran in Hong Kong at ecurran8@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Henry Hoenig, Brett Miller

©2018 Bloomberg L.P.