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    Attention turns to Fed and BoJ meetings amid market volatility and oil rout

    Two major central banks will hold their policy meeting this week, with the US Federal Reserve and Bank of Japan meeting for the first time in 2016. While the Fed is almost certain to keep rates steady on Wednesday, there’s been increased speculation in recent days that the BoJ might surprise with policy easing on Friday.

    The renewed slide in oil prices since the start of the year has brought back the threat of deflation. Crude oil prices were back below $30 a barrel today and with headline inflation already close to zero in most advanced economies, consumer prices could soon start falling again. This would make it difficult for central banks to justify existing policy.

    The Fed said at its December meeting that it was reasonably confident that inflation will rise over the medium term. However, with oil prices falling more and staying low for longer than expected, the Fed might need to clarify what it means by “gradual” increases in the federal funds rate.

    Similarly, the Bank of Japan has repeatedly stressed that it is confident that it will meet its 2% inflation target by March 2017. But, even though Japan has made significant progress in raising “core core” inflation (which strips out food and energy) to just under 1%, weaker inflation expectations are at risk of pushing prices down again.

    The Fed will probably point out in its meeting statement the increased downside risks from the market volatility and slowdown in emerging markets but is not expected to make a major shift in its existing outlook. It is also likely to keep the markets in suspense on its outlook for future rate rises until the March meeting when it will publish the updated dot plot on the FOMC’s forecasts of rate increases. At the December meeting, the FOMC had forecast four rate hikes for 2016. This is now looking very unlikely and the markets have priced in just two increases.

    Some analysts have said that the recent heavy losses in the stock market could filter through to lower consumer spending as household net worth declines as a result. This may force the Fed to reverse policy just months after hiking rates.

    In Japan, expectations of further easing were dampened when the BoJ made some minor tweaks to its QQE program in December. But reports last week that the Bank is considering looser monetary policy as early as its January 28-29 meeting cheered the markets. Expectations were further fuelled when BoJ Governor Haruhiko Kuroda said that long-term inflation expectations have been somewhat weak. Kuroda also reiterated that the Bank won’t hesitate to adjust policy if necessary but ruled out negative interest rates.

    Stock markets have fallen significantly in both the US and Japan since the start of the year. The S&P 500 in the US has lost around 8%, while Japan’s Nikkei 225 index is down by about 12%. The heightened uncertainty has increased the yen’s appeal, with the dollar declining from around 122 yen post the Fed’s December meeting to around 118 yen currently.

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