What is the reason behind the Bank of Japan new approach to QE?

Not that long ago the BoJ (Bank of Japan) has officially stated that they decided to abandon their 6 trillion yen target to buy ETFs (the Exchange Traded Funds). And while they are still holding on to their upper limit of 12 trillion yen for the purchases (the limitations were introduced as a measure in response to the pandemic in March 2020), they have decided to quit buying Nikkei 440 and Nikkei 225. Instead of them, they will shift to the ETFs based on Topix.

This is a major reshuffling as for the past decade the Bank of Japan was tracking Nikkei 225 and Nikkei 440, and thanks to it, they became the biggest stocks and bonds holder in the country. In February, their total ETF holdings hit the sum of 47 trillion yen.

Even despite the success, the scheme was rather unsustainable according to the critics. It was even labeled as market-distorting. Nikkei index is actually price-weighted, meaning that their worth is hugely decided by the worth of an individual stock. So the stocks with higher prices have a big and disproportionate impact on the movement of the index.

Some could interpret this as taxpayer-funded subsidies offered to the biggest companies in the country. What’s interesting, this drive happens at the time of favouring the Topix (Tokyo Stock Price Index) represented stocks. Well, you could probably call the BoJ’s actions distorting the market, as well as warping the trading and pricing.

They of course are trying to fix that right now. Haruhiko Kuroda is the one who reduced the purchases of Nikkei 225 funds tracking. This completed the shift to the Topix and looks like it corresponds to the market’s behavior and trends. In reality, this could also mean that Nikkei will not outperform Topix anymore, and could seed the growth of the Tokyo Stock Price Index itself.

Topix and the Bank of Japan

Topix, or the Tokyo Price Index shows us the stock prices of the Stock Exchange in Tokyo. How is it different from the Nikkei? The latter one is, as we already established, price-weighted.

After the Bank of Japan’s move, the consequences don’t look too radical, because it is more of the correction of flawed policy. But what is interesting, the Bank of Japan’s actions and decisions seem to be exactly opposite to what other central banks are doing.

Not that long ago Jay Powell from the Federal Reserve swore to keep providing support to the economy of the United States. And although the GDP forecasts were upgraded to 6.5% after the stimulus package promised by President Joe Biden, Federal Reserves will hold the interest rates near zero and promised to keep purchasing the debt of $120 billion every month.

ECB (the European Central Bank) has recently sped up the purchases of bonds in the PEPP (Pandemic Emergency Purchase Programme).

Why is Japan acting differently from others?

To put it in simple words, the Bank of Japan has decided to move away from this kind of aggressive measures. By that, they will allow the bigger fluctuation of 10-year bond’s yields (they will allow the fluctuation of more or less 0.25 per cent).

This means less intervention, but also higher bonds yields. Equities still will be purchased, but the maximum 12 trillion yen cap will be saved. There is no minimum though, so in theory, the purchases could be close to zero.

And the intervention from BoJ will occur only when the market falls. In the long-term, it will allow nimbleness and flexibility, and the possibility to target any stimulus measures with carefulness and high selectivity (instead of flooding the country with money).

Will that have an effect on the global markets?

It could be perceived as an optimistic sign after the whole year of uncertainty. With things looking like we’re emerging from the pandemic, the projections say that the global economy could grow by even 4.7 per cent. And as Japan managed the Covid-19 better than most of the rest, their recovery could be impressive.

To read more about the outcomes and some projections of the post-Covid era, visit Disruption Banking’s piece: https://disruptionbanking.com/2021/03/29/why-is-the-bank-of-japan-changing-its-approach-to-qe/.

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