Bank of Japan unveils long-term rate target in major policy overhaul

Japan’s central bank kept rates steady at its meeting on Wednesday, but issued a plethora of fresh changes to its policy approach, marking its latest attempt to boost prices and goose economic growth.

Among the changes, the Bank of Japan (BOJ) said it would make yield-curve control a centerpiece of its new policy framework, by a seven-to-two vote.

It said it would buy 10-year Japan government bonds (JGBs) so that the yield would hover around zero percent while keeping a lid on short-term rates. The deposit rate was left unchanged at negative 0.1 percent.

Additionally, the central bank abandoned its target for expanding the monetary base, saying it aimed to expand the base until growth in the consumer price index (CPI) excluding fresh food “overshoots” its 2 percent target.

The BOJ said it currently planned to continue making JGB purchases more or less in line with the current 80 trillion yen (around $787.63 billion) annual pace of expansion of its holdings, but it eliminated any guidelines on the maturity range it would make purchases within.

Markets may read the statement as a “whatever it takes” moment for expanding the monetary base until Japan begins to see some of the inflation it has long sought.

The BOJ emphasized, however, that it wasn’t expecting its moves to be a one-off solution to Japan’s economic doldrums, with the pace of economic recovery likely “slow.” It said the central bank “should commit itself to expanding the monetary base in the long run.”

While the BOJ has booted Japan’s economy out of deflation, it has had limited success in generating the desired levels of inflation. In July, Japan’s consumer price index (CPI) fell 0.4 percent from the year-earlier month, although it rose 0.3 percent when food and energy were excluded.

The Nikkei was up nearly 2 percent by the market close, compared with gains of around 0.3 percent just before the announcement, and trading slightly negative during the morning session. The Topix tacked on around 2.7 percent.

The dollar was fetching as much as 102.78 yen after the decision, compared with around 101.80 yen just before the announcement and as little as 101.09 yen earlier in the session.

The 10-year Japan government bond yield surged into positive territory, trading as high as 0.011 percent, compared with levels as low as negative 0.062 percent before the announcement. The yield later retreated, trading around negative 0.022 percent at 2:02 p.m. SIN/HK.

The changes indicated the central bank’s promised comprehensive review of the effectiveness of its policies was fruitful, and many of the new policies appeared to address critics’ concerns about negative effects of the BOJ’s aggressive easing measures.

While the central bank refrained from cutting deposit rates deeper into negative territory, it added that options for additional easing included cutting the short-term policy interest rate and reducing the target level for the long-term interest rate as part of its efforts to control the yield curve.

At a press conference following the decision, BOJ Governor Haruhiko Kuroda said the central bank will not hesitate to ease policy further, while adding that the commitment to overshoot inflation was aimed at boosting inflation expectations.

Critics had noted that the BOJ’s historical bond-buying efforts had flattened the government bond yield curve. That tends to weigh on the earnings of banks because they borrow at short-term rates to lend at long-term rates; the lack of compensation for taking on risk also tends to discourage banks from lending.

As part of the comprehensive assessment, the BOJ noted that an excessive flattening of the yield curve could have a negative impact on economic activity and dampen sentiment, in part by creating uncertainty over the sustainability of the financial system broadly.

The outcome of Wednesday’s BOJ meeting had been a bigger nail-biter than usual. Predictions had ranged widely from expectations the BOJ will cut interest rates deeper into negative territory, to changing the size or make-up of its quantitative and qualitative easing (QQE) asset purchases, to trying to steepen the yield curve or to doing nothing at all.

Marcel Thieliant, a senior Japan economist at Capital Economics, noted that the change to yield-curve targeting opened the door to allowing the BOJ to scale back its government-bond purchases later.

One long-running concern about the BOJ’s quantitative and qualitative (QQE) easing program had been that the central bank, which already owns more than a third of all JGBs, would eventually run out of bonds to buy.

“This move reflects concerns about the sustainability of large-scale JGB purchases as well as about the profitability of insurance companies, which tend to hold very long dated government bonds whose yields have fallen sharply after the introduction of negative rates,” Thieliant said in a note Wednesday. “Today’s decision leaves the door open for a tapering of asset purchases.”

At the same time, he expected the BOJ would soon cut its policy rate, most likely at its November meeting.

Not everyone was impressed by the BOJ’s paradigm change.

“The conclusion to the comprehensive review is underwhelming,” Patrick Bennett, a foreign-exchange strategist at CIBC, said in a note on Wednesday.

“Today’s actions can’t manufacture inflation, and never could. A steeper yield curve might be seen as a boon to banks and funds, but without growth and/or inflation, investors, be they pension or life companies or similar, will simply buy the back end and drive the curve flat or flatter again. The problem is not the price of money but the demand for it,” Bennett said.

In another change that may have been aimed at addressing criticism of its asset-purchase program, the BOJ tweaked its exchange-traded fund (ETF) purchase plan.

The BOJ said that purchases of 3 trillion yen annually would be divided among ETFs based on the Topix, Nikkei 225 and JPX Nikkei 400 indexes, with the maximum amount of each ETF purchased roughly proportionate to the ETF’s total market value.

But the central bank added that the remaining 2.7 trillion yen of its annual ETF purchases would be aimed at funds tracking the Topix index.

Analysts had previously noted that the BOJ’s ETF purchases had not only appeared to “nationalize” the stock market, by making the central bank an indirect owner of large company stakes, but it also distorted the market by focusing mainly on the Nikkei 225 index.

That index is weighted by the price of individual stocks, compared with other indexes, such as the broader Topix, which are weighted by market capitalization.

For example, Uniqlo owner Fast Retailing had the largest weighting in the Nikkei index, but that was primarily due to its high share price after avoiding any stock splits since April 2002. Toyota Motor, which has the highest market capitalization of any stock in Japan, was only 15th by weight in the index.

Source: Reuters