×

BOJ's stimulus decision complicated by domestic data weakness, external risks

The Bank of Japan (BOJ) is expected to have a tough time deciding whether or not to unleash fresh stimulus on Thursday against a conflicting backdrop of domestic economic weakness and global geopolitical risks.

The central bank has held its fire since the shock-and-awe introduction of negative rates in January, and the majority of market participants expected that trend to continue this month, with a possibility of action in July.

Governor of the Bank of Japan Haruhiko Kuroda answers questions during a press conference in northern Japan on May 21, 2016.
Kazuhiro Nogi | AFP | Getty Images
Governor of the Bank of Japan Haruhiko Kuroda answers questions during a press conference in northern Japan on May 21, 2016.

"Central banks around the world, especially the Japanese, are sitting on their hands waiting to see how global developments over the next week or two are going to unfold," explained Kathy Lien, managing director of BK Asset Management, referring to the Federal Reserve meeting held on Wednesday and U.K. Brexit referendum in particular.

While the U.S. central bank held off on a rate hike as widely expected, investors are parsing the Fed's statement for hints on a potential increase in July. Meanwhile, Britain votes on June 23 on whether to will stay in or leave the European Union.

The Fed's moves and the upheaval caused by a Brexit could have a sharp impact on the safe-haven yen, which has already rallied 13.5 percent year to date against the greenback, inflicting pain on the export-centric companies listed on Japan's benchmark Nikkei 225 index.

The yen was at a level where it's screaming for monetary intervention but the timing just wasn't right for more stimulus, said Lien.

Like many others, she anticipated July was the earliest time Governor Kuroda could act, adding, "Central banks around the world also really want fiscal stimulus, they're pressurizing politicians to do their part so I think that's what Japan is focused on right now as well."

But there are commentators betting on action this week. They point to stubbornly low Japanese consumer price inflation (CPI) and the rallying yen as key factors justifying further quantitative and qualitative easing (QQE).

"The fundamental case for additional BOJ easing remains strong," Izumi Devalier, economist at HSBC, explained in a recent note. "In our view, the longer the board waits to address downside risks to the economy and prices, the more markets will question the central bank's commitment towards its inflation target."

Japan's April's CPI report — the latest available - showed a 0.3 percent annual fall, the second straight month of decline and a far cry from the BOJ's target of 2 percent inflation by early 2018.

"I am expecting the BOJ to move this month. It's not the consensus call but they have surprised in the past. With the Nikkei having sold off and the yen rallying, the policies they have aren't working so I think they need to be aggressive," Adam Reynolds, CEO of Saxo Bank Group, said. But further easing would only temporarily weaken the yen as caution over external risk events would continue to support the currency, Reynolds warned.

Devalier argued that a failure to act could cause problems down the line for the BOJ.

If the BOJ did abstain from stimulus in June, that could weigh on market confidence in the central bank's commitment to increasing inflation, potentially translating into a stronger currency and making the BOJ's job even more difficult, Devalier said.

Among potential easing tools, she said she expected the BOJ to raise its monetary base target to 90 trillion yen a year, from 80 trillion yen currently, and expand the scope of its asset purchases to include local government bonds and government agency (FILP) bonds.

Follow CNBC International on Twitter and Facebook.