Japanese monetary trends remain lacklustre despite ultra-aggressive QE. Six-month expansion of narrow money M1 slipped again in September while growth of broad M3 was stable. Bank lending* has also failed to accelerate – see first chart.

As previously explained, the muted response of monetary growth to QE partly reflects stepped-up sales of government securities by banks, which have offset the Bank of Japan’s purchases. Holdings of such securities by domestically licensed banks** fell by ¥24.6 trillion between March and August (the latest available month) versus an increase of ¥38.0 trillion at the BoJ over the same period.

Monetary growth is weaker in real terms because of a pick-up in inflation, mainly due to the weaker yen. The six-month change in real M1 in September was the lowest since July 2012, while that of real bank lending turned negative in August – second chart. Real narrow money expansion is lower in Japan than in other major economies – third chart.

Real money growth, of course, will be squeezed further by the April 2014 sales tax rise from 5% to 8% – expected to boost consumer prices by about 2.5%.

The optimistic scenario is that banks will stop selling government securities, allowing ongoing QE to boost nominal money growth substantially before the tax hike hits. There is some support for this scenario in statistics showing a sharp slowdown in the rate of decline of their holdings in July and August*. The September monetary data, nonetheless, were disappointing. The assessment here of Japanese economic prospects will remain cautious until monetary trends improve significantly.

*The lending series in the chart adjusts for special factors, data for which are available only up to August.
**This category is a sub-set of the banking sector, which also includes Japan Post, among other institutions.
***Banks’ holdings fell by only ¥1.0 trillion July / August versus a ¥23.6 trillion reduction during the second quarter.