QE enthusiasts expected the bond-buying blitz launched by incoming Bank of Japan Governor Kuroda in April 2013 to boost the broad money supply substantially – one commentator suggested a 10% increase over a year. The view here was sceptical, on the grounds that higher BoJ purchases would be largely offset by stepped-up selling by banks, whose demand for liquid securities would fall as QE expanded their reserves – see previous post.

This view, so far at least, has proved correct. Banks reduced their investment account holdings of Japanese government bonds by a further ¥5.8 trillion in January (the latest available month), neutralising two-thirds of the impact of BoJ buying of ¥8.4 trillion. Annual growth of the broad M3 money supply measure slipped back to 3.2% in February – little changed from 2.5% in March 2013.

The QE lift to nominal money supply growth has been more than offset by higher inflation due mainly to the weaker yen. Real money expansion is lower now than in early 2013, helping to explain recent disappointing economic performance – see chart.

What happens next? Inflation will be boosted mechanically by next month’s sales tax hike but the yen effect is now fading and wage rises remain muted. If nominal money growth is stable, real trends may improve later in 2014 as price rises moderate, promising better economic conditions in 2015.

The risk is that the BoJ will raise the QE stakes, leading to further yen weakness that keeps inflation elevated and real money growth depressed – assuming, reasonably, that QE pass-through to nominal money trends remains minimal.

The BoJ, in other words, may sacrifice economic growth on the altar of its obsession to achieve 2% inflation.