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bank of japan and equity markets

Will fortune favour a bold BOJ?

August 2018

Steve Donzé, Senior Macro Strategist, Hiroshi Matsumoto, Deputy Head of Investments and Products

The BOJ takes a step towards controlling the equity market in a shift that could generate fresh gains for Japanese stocks.

The Bank of Japan has taken a radical step towards controlling the country’s equity market, in a stealth policy move that could boost Tokyo stocks.

The clue can be found in a short phrase in the BoJ's monthly statement which - judging from the lack of immediate market reaction - has gone largely unnoticed. The central bank said: “With a view to lowering risk premia of asset prices in an appropriate manner, the Bank may increase or decrease the amount of purchases depending on market conditions.”

Japan’s equity risk premium, or the difference between stocks' earnings yields and bond yields, stands at 7.5 per cent, more than 100 basis points above the average since 2000 of 5.2 per cent. Our calculations show TOPIX could rise by as much as 20 per cent if the BOJ were to conduct share purchases to lower the equity risk premium to 6 per cent, the lowest point reached during Governor Haruhiko Kuroda’s term which started in March 2013. 

The BOJ is no stranger to such radical shifts in policy to influence financial market pricing. It performed a similar feat in the bond market when it introduced Yield Curve Control policy in 2016. Under YCC, the BOJ undertakes bond purchases to keep the 10-year JGB yield at zero.

This policy has also allowed the BOJ to reduce its annual bond purchases by JPY47 trillion from its JPY80 trillion target without disrupting financial markets, effectively conducting “stealth” tapering of its QE.

But this time, the BOJ may have to buy a far greater volume of stocks than its JPY6 trillion target if it is serious about lowering the risk premium. This is because the central bank owns just 5 per cent of Japanese equity markets but more than half of all JGBs. 

Rising premium

12-month forward earnings yield of TOPIX minus 10-year JGB yield

ERP
Source: Thomson Reuters Datastream, data covering period 31.01.2000 - 29.06.2018