Can monetary policy be credited? Inflation expectations had been rising in H1 2011 before abruptly reversing course in July, after the Bank of Japan (BoJ) left policy unchanged just as the Fed intimated more QE (driving the yen higher), suggesting a strong monetary policy influence. But the breakeven began rising rapidly again in mid-January, several weeks before the BoJ’s pivotal 1% inflation goal announcement on February 8. Indeed, inflation expectations actually stabilized after the February 8 announcement for about a week before jumping thereafter.
The apparent catalyst for the sudden increase in the breakeven was a very strong rebound in machinery orders, the largest in four years, announced in mid-January, which rekindled expectations of a turnaround in the Japanese economy. The BoJ’s policy moves thereafter added momentum by not only pushing inflation expectations higher but also lowering nominal yields on government bonds, bringing long-term real rates down sharply.
It would seem these lower medium-term real rates are enticing borrowers back into the lending market, at least in the household sector. The latest Senior Loan Officers Survey out of the BoJ, conducted between June 11 and July 9 and released last week, showed an improvement in household demand for credit, pulling the four-quarter moving average (4qma) for consumer credit demand into positive territory for the first time since mid-2008.
Of course, there are plenty of pitfalls in assuming such a causal link. There has been a substantial improvement in consumer confidence across the board recently, driven by improving income and employment conditions (or at least the perception thereof), which is probably having the biggest impact on borrowing behavior. Furthermore, business credit demand worsened in the latest survey, particularly for small firms, which suggests that the real interest rate channel has not changed firm behavior, at least not yet.
We also have to be careful about putting too much stock in breakevens. Inflation-indexed bonds have a much smaller market volume than JGBs, such that a few large buyers may be able to affect prices more easily than in the regular government bond market. Thus, breakevens may not be as reflective of economy-wide expectations as the JGB market. That said, consumer price expectations are also demonstrating some positive momentum, albeit much less pronounced than what breakevens are showing. In the end, it seems monetary policy is at best amplifying underlying macroeconomic dynamics, but not particularly driving them.