Kuroda does what he can (but it won’t be enough)

After all the speculation, today’s BoJ announcement saw it make significant innovations to its policy framework. While there was no change made to the contentious -0.10% policy interest rate or the main asset purchase volume targets (e.g. JGB purchases will be maintained ‘more or less’ in line with the current pace of increase of ¥80trn per year), the BoJ unveiled a range of new measures. In particular, it announced: 

  • A new ‘Yield curve control’ framework, with the aim in particular to keep 10Y JGB yields ‘more or less’ at the current level (around zero per cent). To achieve that aim, the BoJ will conduct fixed-rate purchase operations right across the curve, from maturities of 2Y up to 40Y. And to give itself greater flexibility regarding the relative amounts of bonds it will buy at different maturities, the BoJ abandoned its previous guideline average maturity of 7-12Y for its JGB holdings.
  • To supplement the fixed-rate JGB purchase operations, the BoJ announced new fixed-rate funds-supplying operations for banks for up to 10 years, up from just one year at present,  with a fixed zero per cent interest rate.
  • While the BoJ maintained its objective to achieve the 2% inflation target ‘at the earliest possible time’, it made a new commitment to strive to overachieve, pledging to continue to expand the monetary base at least until core inflation has exceeded 2% and has been maintained  above 2% in a “stable manner”.
  • Going forward, the BoJ left open all possible options to ease further, including via a further cut to the policy rate or a cut in the target 10Y yield level – both considered ‘key benchmark rates’. And it also noted that it would still be possible to expand further the asset purchase programme, or – seemingly as a last resort – the monetary base target.

The overall package seeks to address a number of recent concerns about BoJ policy. For example:

  • With bank margins having been squeezed mercilessly for several years, and insurers and pension funds also alarmed by the drop in super-long rates in the first half of the year, the BoJ aims to soften the impact of the negative rate policy on financial institutions by achieving some pre-determined adequate steepness of the yield curve.
  • The shift to a yield curve target also ought to address concerns that the BoJ might eventually struggle to keep increasing its JGB holdings at the current rate, which would have risked perceptions that it was being forced to ‘taper’ against its will and was thus failing in the implementation of its policy – which would be highly damaging to credibility. Instead, the volume of assets bought will now be given secondary importance to the impact on yields –an elegant way to potentially taper in all-but name, while minimising the risk of adverse market consequences.
  • Moreover, the pledge to strive to overachieve on its inflation target to compensate for recent years of underperformance, coupled with the clear signal that policy will be ‘low for (much much) longer’ made via the new funds-supplying facility of fixed-rate loans of up to 10Y maturity, goes beyond the norms of central bank policy making anywhere. That might just help to halt, or even reverse, the steady decline in inflation expectations seen over the past couple of years.

Comments by Kuroda in his post-meeting press conference suggest, among other things, that the BoJ doesn’t intend to ‘fine-tune’ policy on a frequent basis going forward, and that he considers the current shape of the yield curve to be appropriate. But plenty of questions remain, particularly regarding implementation of the ‘yield curve control’ framework. For example, while the large share of the JGB market held by the BoJ (currently more than one third and set to rise towards 50% by end next year) means that it should be relatively confident in achieving its desired shape of the yield curve, how its perceptions of the ‘appropriate’ curve will evolve over time is unclear.

Indeed, the BoJ acknowledges that the optimal shape of the curve should change in response to news on a range of matters including inflation, expectations, economic growth, corporate bond yields, rates on bank loans, other market developments, etc. Quite how, and how often, it will revise its judgement (which might, of course, be far from optimal) remains to be seen. And, of course, the charade that somehow the JGB market is anywhere near ‘normal’ in any sense of the word can now be firmly junked – it is now explicitly rigged by the central bank.

Most importantly, however, will this all work? The BoJ cannot be criticised too much for a lack of ambition where its own policy tools are concerned, with the frontier of global monetary policy pushed out further. But, ultimately, there was no easing in the main policy settings announced today. The BoJ is also telling us that it is happier with a yield curve that is steeper than we had just a few weeks ago – arguably representing a tightening of actual monetary conditions. And, if the BoJ’s commitment to its yield curve target is credible, today’s announcement may indeed result in a tapering of its JGB purchases.

So, the main thrust of today’s policy changes is to try and shift inflation expectations higher via its ambition to overachieve on the inflation target and to as good as pre-commit to super-low policy rates for the coming decade. That’s laudable. Whether this works depends very much on whether anyone thinks the inflation target is credible. And certainly, the recent drop in inflation expectations demonstrates that the BoJ’s credibility has fallen over recent months.

Ultimately, the BoJ does not operate in a vacuum. And given the relatively limited support coming from fiscal policy; Japan’s woeful demographics and other structural weaknesses; the weakness of global demand; and the susceptibility of the yen to bouts of swings in global risk aversion, we very much doubt that – for all the BoJ’s efforts – inflation will manage even to rise significantly above 1%Y/Y on a sustained basis. So, this is unlikely to be Kuroda’s last word. Indeed, there seems reason to expect further easing – perhaps via a 10bps cut in the policy rate to -0.20% (with the 10Y yield target left unchanged at zero) – next year. And, without a fundamental change in the macroeconomic policy mix in Japan that incorporates a much larger fiscal boost – something that’s not on the horizon – the negative policy rate and 10Y yield may well end up staying at or below current levels for the next decade or beyond.

JGB yield curveYield Curve_Sept16Source: Bloomberg and Daiwa Capital Markets Europe Ltd.

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