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bank of japan and equity markets

August 2018

Fortune favours a bold BOJ?

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

Will market fortune favour a bold Bank of Japan?

The BOJ has taken a radical step towards controlling the country’s equity market, in a stealth shift in its monetary policy that could generate fresh gains for Tokyo stocks.

The clue is in a short phrase 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, a difference between 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 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 subtle 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 effect on overall monetary stimulus could well be the opposite – the BOJ may have to buy more 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 – its financial clout here is weaker, compared with that in the JGB market, nearly half of which is held by the central bank.

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