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Japan Output Exceeds Capacity, BoJ Slows Bond Purchase

BoJ’s view is that Japan’s economy is gathering enough momentum for inflation to accelerate toward its 2% target
The economy expanded an annualized 1.6% in the October-December quarter, marking the eighth straight quarter of gains.The economy expanded an annualized 1.6% in the October-December quarter, marking the eighth straight quarter of gains.

Japan's economic output exceeded its full capacity by the most in a decade in the October-December quarter, the Bank of Japan estimated, a positive sign for the central bank as it seeks to accelerate inflation to its elusive 2% target.

A positive output gap occurs when actual output exceeds the economy's full capacity, as factories and workers operate above their most efficient level to meet strong demand, Reuters reported.

A growing positive output gap shows that inflationary pressure is building and thus an important indicator for central banks.

Japan's output gap, which measures the difference between an economy's actual and potential output, stood at plus 1.50% in October-December, staying in positive territory for a fifth straight quarter, the Bank of Japan estimate showed on Wednesday.

The result, which followed a 1.14% positive output gap in July-September, backs up the BoJ's view that Japan's economy is gathering enough momentum for inflation to accelerate toward its 2% target.

But the central bank is likely to hold off on whittling down its massive stimulus with inflation distant from its target. "Inflation has been slow despite a tightening job market," BoJ Governor Haruhiko Kuroda told parliament on Tuesday.

"Debating an exit strategy now would cause confusion," he said, stressing that the BoJ will maintain its ultra-easy policy until inflation is stably above its target.

Tapering to Continue

After three years of heavy asset buying failed to fire up inflation, the BoJ switched its policy focus in 2016 to one targeting interest rates instead of the pace of money printing.

Under a policy dubbed yield curve control, the BoJ now guides the short-term interest rate at minus 0.1% and the long-term rate around 0%. It also keeps a loose pledge to buy bonds so its holdings grow at an annual pace of around 80 trillion yen ($750 billion).

Actual purchases, however, have slowed recently as the BoJ's dominance in the bond market allows it to keep yields low with reduced buying. The slowdown is also in response to growing criticism that the BoJ's huge purchases are drying up liquidity.

Separate BoJ data released on Wednesday showed the balance of the bank's bond holdings at end-March were up 48.6 trillion yen from a year ago, the smallest gain since November 2013.

The BoJ started its huge asset-buying program, dubbed "quantitative and qualitative easing", in April 2013.

"Yield curve control is allowing the BoJ to steadily retreat from the bond market," said Katsutoshi Inadome, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities. "But the BoJ's presence is still too big, given the negative effect such as falling market liquidity," he said.

Japan's economy expanded an annualized 1.6% in the October-December quarter, marking the eighth straight quarter of gains, on robust global demand and capital spending. But core consumer inflation stood at 1% in February, well below the BoJ's 2% target, as slow wage growth keeps consumers from boosting spending.

Services PMI Slows

Activity in Japan’s service sector expanded at the slowest pace in 17 months in March as new business growth cooled, suggesting a slight moderation in overall economic growth.

The Markit/Nikkei Japan Services Purchasing Managers Index fell to 50.9 in March on a seasonally adjusted basis from 51.7 in February.

It was the lowest reading since October 2016, although the index remained above the 50 threshold that separates expansion from contraction for the 18th consecutive month.

“Despite PMI data signaling disappointing output and demand conditions, prospects appear upbeat,” said Joe Hayes, economist at IHS Markit, which compiles the survey. “Incoming new business has grown for 20 successive survey periods, and firms expect this trend to continue, as indicated by a solid degree of optimism towards future activity.”

The index for new business eased to 51.0 from 51.9 in February, though future business expectations fell only a touch with overall optimism levels remaining robust.

The composite PMI, which includes both manufacturing and services, fell to 51.3 from 52.2 in February.

A final reading on a separate manufacturing survey also showed some modest loss of momentum in the factory sector, suggesting the pace of economic growth could slow over the year if consumer spending ebbs.

 

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