Japan: dovish BoJ to benefit equities

1. What happened?

The Bank of Japan (BoJ) has kept interest rates unchanged with the uncollateralized overnight call rate left at 0-0.1% in line with expectations. In a unanimous vote, the BoJ also maintained its stance on the purchase of Japanese government bonds (JGB), commercial paper (CP) and corporate bonds as announced in the previous meeting on March 19. The BoJ had last month decided to continue JGB buying at the same level as before, while gradually reducing the purchases of CP and corporate bonds and eventually discontinuing this in about a year.

In terms of forecasts, the BoJ has lowered its GDP growth outlook for fiscal years 2023 (ended March 2024), 2024 and 2025 to 1.3-1.4%, 0.7-1% and 0.8-1.1% respectively, citing lower private consumption and disruption to some automakers’ shipments. Its inflation outlook was revised up to 2.8%, 2.6-3.0% and 1.7-2.1% respectively, due to a rise in crude oil prices and the waning effect of government subsidies.

Recent macroeconomic data has been favourable with manufacturing PMI rising to 49.9 in April from 48.2 in March, which although still contractionary is now very close to the 50 threshold for growth. Services PMI also gained further to 54.6 in April from 54.1 in March, reflecting strong inbound tourism.

The Tokyo core CPI (excl. fresh food) for April (data released early today) was 1.6%, much weaker than consensus estimates of 2.2% and below the BoJ’s 2.0% target. Although some moderation was expected from the previous month’s reading of 2.4%, the big drop was largely due to a one-off effect from a high school tuition fee waiver for all income groups by the Tokyo metropolitan government, which shaved off about -0.5% from the overall figure. Furthermore, subsidies were provided to households with children attending private schools. As a result, services inflation came in lower at 0.8% compared to the March reading of 2.0%. However, goods inflation at 3.0% vs. 3.3% in March was still above the BoJ target. Super core CPI (excl. food and energy) eased to 1.8% from 2.9% in March.

2. How did markets react?

Following today’s announcement, JGB yields (10-year) went higher to 0.92%, compared to 0.895% yesterday. JPY showed further weakness and it depreciated by -0.67% to 156.8 against the USD today. JPY is now at its lowest level in more than 30 years. Japanese equities were slightly up, with the Topix rising 0.86% on the day.

3. What does it mean for investors?

Manufacturing activity seems to be gradually turning around, particularly helped by the semiconductor upcycle and the IT sector. However, we expect the BoJ to remain in a “wait and watch” mode in terms of its next rate hike move, until it sees further evidence of the consumption story and a virtuous growth cycle triggered by a rise in real wages.

The JPY’s recent depreciation has led to market speculation about a possible intervention by the BoJ. As recent inflation was below expectations, and the growth outlook could be affected by export sector uncertainty, we however think that the BoJ may not immediately intervene in the FX market. Overall, the recent JPY depreciation should be positive for exporters and should help the BoJ to bring inflation in line with its targets in the longer term.

Upcoming data next week will be closely monitored. Several macroeconomic indicators will be released including the unemployment rate, industrial output, retail sales, housing starts and the consumer confidence index. A tight labour market, along with expectations of decent retail sales growth and rising consumer confidence should confirm the strength of the domestic market.

About 20% of the Topix (measured by market cap) will present Q1 earnings data this week. Excluding the utilities (impacted by a cap on energy prices to protect consumers), profits are expected to have increased by an average of 14% YoY. Furthermore, corporates will guide on their business prospects for the new 2024 financial year, which began in April. The consensus expects further strong profit growth of 10%.

Japanese equities should continue to benefit from the accommodative monetary policies and weak JPY. The recent correction of -5% for the Topix from its all-time high and a FY24E P/E of 14.7x provides an attractive entry point. In terms of sectors, we continue to prefer banking, IT and consumer discretionary driven by the consumption story. These sectors have corrected -4%, -11% and -7% respectively from their previous highs and so offer a good buying opportunity.