Japan's monetary easing should buy time for long-term solutions

Through a temporary economic boost.

According to Fitch Ratings, the Bank of Japan's expansion of monetary easing can buy Japan additional time to resolve its long-term structural economic and fiscal challenges by reducing pressure on the public finances and potentially boosting economic output in the short to medium term. "However, without efforts to address these deeper issues, the benefits will probably prove temporary."

Fitch Ratings added that the recent announcement of "a new phase of monetary easing both in terms of quantity and quality" has already pushed down both the yen and Japanese government bond yields.

"This shows how the BoJ's ability to issue one of the world's reserve currencies remains a powerful asset, helping to keep sovereign debt servicing costs low and potentially boosting Japanese exports through a weaker currency," said Fitch Ratings.

"Experience in other major advanced economies shows that quantitative easing is not in itself an economic panacea. QE cannot be extended indefinitely. However, in the short to medium term, it can buy time to tackle other issues by holding down the government's debt servicing costs and by giving a broader fillip to activity," it added.

"Therefore, developing and implementing a credible fiscal strategy over the medium term, and enacting structural reforms to raise the real economic growth rate remain central issues for Japan and its sovereign credit rating," it said further.

Fitch Ratings explained that its downgrade of Japan to 'A+' in May 2012, and the Negative Outlook on the rating, already reflect the risk posed by high and rising general government debt ratios.

"As we said then, a lack of new fiscal policy measures aimed at stabilising public finances amid further rises in general government debt ratios could lead to a downgrade."

The BoJ said it will increase purchases of government bonds to JPY7.5trn per month out to 2014 and extend purchases to longer-dated government bonds and other assets. The purchases will double the monetary base in two years as the BoJ aims to hit the 2% inflation target agreed with Mr Abe, noted Fitch Ratings.

"By extending its JGB purchases out along the yield curve and including other assets such as ETFs, the BoJ may be more effective in boosting the supply of credit to the domestic economy than it has achieved so far. However, given the persistent weaknesses in the Japanese economy after a protracted period of deflation, we are doubtful that inflation will be close to or exceed 2% for a sustained period over the next two years," said Fitch Ratings.

"We expect an important channel for Japan's quantitative easing will be through depreciating the exchange rate to boost export competitiveness. While global partners have tolerated a weaker yen so far, if that changed, Japan could come under pressure to moderate its policy stance," it added.