BOJ may shift policy focus to rates as monetary firepower wanes

EghtesadOnline: The Bank of Japan could shift negative interest rates to the primary focus of its monetary policy on Wednesday, heightening market disquiet over what any move away from quantitative easing reveals about the waning firepower of global central banks.

News ID: ۷۳۷۰۳۵

19 September 2016

With three years of massive money printing failing to push up inflation, the BOJ is expected to move away from shock therapy and towards a protracted battle against deflation, say sources familiar with its thinking.

According to Reuters, the BOJ's "quantitative and qualitative easing" (QQE) has been a signature policy of Governor Haruhiko Kuroda since 2013 that aimed to shock the economy out of stagnation and change households' deflationary mindsets.

While the central bank is unlikely to ditch QQE completely, altering its emphasis would herald an end to the "shock and awe" approach that made Kuroda's policies unique compared with the gradualist approach preferred by his predecessors.

A less aggressive approach would also come as a world of tame growth and low inflation force the U.S. Federal Reserve to go slow on raising interest rates and the European Central Bank to concede the limits of what monetary policy alone can achieve.

Policymakers got a taste of how markets might react last week when investors dumped longer-dated bonds on fears the BOJ would slow its purchasing pace.

Super-long Japanese government bond yields have rocketed since the BOJ announced at its July 28-29 meeting its plan to conduct the comprehensive assessment in September.

The 20-year JGB yield, which hovered around 0.125 percent on July 29, hit a six-month high of 0.495 percent on Sept. 14.

The 30-year JGB yield, which hovered around 0.260 percent on July 29, also hit a six-month high of 0.585 percent on Sept. 14.

The challenge for the BOJ will be how to back away from QQE without scaring investors into a stampede out of government bonds.

"The BOJ insists that it still has many tools available. But the costs of using these tools are rising and the benefits are diminishing, especially for its huge asset purchases," said Izuru Kato, chief economist at Totan Research.

"Deepening negative rates has enormous costs too but practically, that's probably the only usable tool left."

The BOJ will debate the changes when it conducts a comprehensive assessment of its policies at a rate review on Sept. 20-21, the same days as this week's Fed policy meeting.

ADMITTING DEFEAT?

Under QQE, the BOJ has been increasing base money - or the amount of money it prints - at an annual pace of 80 trillion yen ($783 billion). Analysts say the BOJ will struggle to buy enough bonds in coming years with its huge purchases draining liquidity.

Sources have told Reuters the BOJ will shift its prime policy target to the 0.1 percent negative rate it charges on a portion of excess reserves financial institutions park with the central bank that was introduced in February.

Wary of a flattening yield curve that risks impairing financial intermediation, it will also seek ways to steepen the curve such as making its bond buying more flexible.

But the BOJ must manage any such shift without giving markets the impression it could withdraw its massive stimulus.

Sources say the board may consider deepening negative rates to show its determination to maintain an ultra-easy policy bias, though analysts doubt whether a deepening could do much to boost growth.

"Any such move won't have much positive effect on the economy," said Yasuhide Yajima, chief economist at NLI Research Institute. "Unless the BOJ accompanies rate cuts with increased asset purchases, it won't help weaken the yen much either."

Kuroda must also muster consensus from a fragmented board, where even those who favour more easing are divided over the most effective method. Some want to shift to a rate target, but others want to keep focusing on expanding asset purchases.

"Kuroda created QQE, so it's his symbol. Making big changes to that would be admitting defeat," one of the sources said. "I wonder whether that's possible while Kuroda is governor."

($1 = 102.1300 yen)