When I met with the Bank of Japan (BoJ) I had two questions for them; i) are they confident that they had the ability to keep 10 year Japanese government bond (JGB) yields at the new target of 0%, whilst also keeping the short-term rate at -0.1%? and ii) how would holding 10yr JGB yields at 0% help ensure that they hit their 2% inflation target?
When I met with the Bank of Japan (BoJ) I had two questions for them; i) are they confident that they had the ability to keep 10 year Japanese government bond (JGB) yields at the new target of 0%, whilst also keeping the short-term rate at -0.1%? and ii) how would holding 10yr JGB yields at 0% help ensure that they hit their 2% inflation target?
The answer I received to the first question left me confident that the BoJ would indeed be able to cap 10yr JGB yields at "around 0%". As detailed below, the central bank now has the ability to manage its asset purchase program around the previous target of Y80 trillion per year to ensure JGB 10yr yields remain close to 0%.
Indeed, most market participants I spoke with agreed that the BoJ would likely be successful in keeping 10yr JGB yields in a 0% to -0.1% range. It is also worth noting that they have not yet defined what "around 0%" actually meant. This will likely depend on the interaction between market perceptions and the BoJ Board.
But the answer to the second question left me far from confident that inflation in Japan would hit 2% any time soon or indeed, for many years to come (as also discussed in Blog 2). One economist that I spoke with stated that the change in the BoJ's monetary policy strategy meant that they had effectively given up on the 2% inflation target. Or at least the BoJ has had to admit that achieving the 2% inflation target will be a long drawn-out battle.
In this context, it is worth reviewing what the BoJ did in their September 'comprehensive reassessment' of monetary policy. Prior to September, Japan’s central bank was using a combination of 'quantitative and qualitative easing (QQE) and negative interest rates (NIR) to ease monetary policy. They were aiming to increase the money base by Y80trn a year, mainly through the purchase of around Y80trn JGB's per year, as well as the purchase of some other assets.
But given the fight to raise inflation to the 2% target was turning into a long battle, the BoJ was forced to change tactics, because at the Y80trn/yr rate of purchase of JGBs, they would have effectively owned the entire free-float of JGB's (i.e. those bonds not held by the banks and other long-term holders compelled to own JGBs) in a few short years.
Indeed, at the Y80trn/yr pace the BoJ is effectively buying 80%-100% of all the bonds issued by the Ministry of Finance (MoF) each month. To put this into numbers, in FY2016 the MoF is issuing around Y10.5trn in JGB's per month while the central bank is buying around Y8trn-Y10trn per month. For 2017, it looks like the MoF's issuance program will be little changed, allowing the BoJ to maintain its own pace of JGB purchases.
However, given the likelihood that the effects of the 2016 monetary and fiscal policy easing will fade into 2017 and that the BoJ's measure of core inflation will remain well below the 2% target next year, there is a growing view that thecentral bank will need to ease monetary policy again in 2017. Indeed, the BoJ representative I met with stated that if inflation and the economy turned out to be weaker than expectations, then they could ease further at both the short end and 10yr part of the yield curve.
By mid-2017 this further monetary policy easing is expected to take the form of a further reduction in the short-term rate to -0.2% or -0.3% (from the current -0.1%) and a reduction in the 10yr JGB yield target from 0% to -0.1%.
However, it is generally accepted that the BoJ will be able to achieve the 10yr JGB yield target without having to maintain JGB purchases at the Y80trn year pace, ie. the ongoing softness of the economy and inflation well below target is likely to see bond yields remain very low. Given this, it is possible that the will be able to 'taper' its JGB purchases to a level less than Y80trn a year in the years to come. Indeed, part of the reason for the switch in policy target is to do exactly that - so that the period of QQE can last longer into the future.
One of the concerns for market participants is that if a view develops that the BoJ is indeed 'tapering' its QQE program, this could propel the Yen even higher and make increased economic growth and higher inflation even more difficult to achieve.
The BoJ did state that when setting negative interest rates and controlling the yield curve that they needed to respond to very clear concerns that negative interest rates were having a bad effect on the Japanese banks, pension funds and insurance companies. To be clear, the BoJ was not so much concerned over bank profitability - but the ability of the banks to act as a transmission mechanism for financial intermediation in the economy.
As noted, there was certainly a general consensus in Japan that the BoJ was highly unlikely to hit the 2% inflation target over the coming years. Indeed, one economist I spoke with stated that "nobody believes the BoJ will hit the 2% inflation target - not even the BoJ."
So the question is: why maintain that target? The answer I got when I asked that question was that 2% is the global standard for inflation targeting and the BoJ did not want to be the only major central bank to abandon this target as this would be seen in a very negative light by the BoJ's global counterparts. This seemed like a poor reason to me. Perhaps this debate will have to await the next Governor is appointed.
Current BoJ Governor Kuroda's term expires in April 2018. One change I noticed from my trip to Japan earlier this year, is that there now seems to be a widespread view that Kuroda will not be reappointed. The decision will be PM Abe's to make and he is considered likely to replace the Governor with somebody who is closer to the government and perhaps more willing to have monetary policy and fiscal policy work in tandem - ie. be more positively inclined towards 'helicopter money'.
Once such candidate is Mr Etsuro Honda - the former economic advisor to PM Abe and currently Japan's Ambassador to Switzerland. He is said to be close to Ben Bernanke and a supporter of more aggressive monetary policy action. An alternative is the current Deputy Governor, Mr. Hiroshi Nakaso - a career BoJ man that is supportive of the current yield curve control policy, or another insider, Mr Masayoshi Amamiya, one of the current Executive Directors. No matter who the next BoJ Governor is, he is likely to have a real challenge on his hands getting inflation up to 2%, or explaining why this target is being changed.
