10 Juli 2018, 14:21 GMT
Source: Bank of Japan, Fidelity International. February 2018
Not rushing for the exits
While other central banks may be preparing to make for the exits from easy monetary policy, the Bank of Japan is standing pat. The BOJ on Friday held monetary policy steady as widely expected, its last meeting under recently reappointed Governor Haruhiko Kuroda's first five-year term.
The BOJ’s stance contrasts with the U.S. Federal Reserve’s steps to unwind its asset purchase program and normalize rates. The European Central Bank this week also symbolically dropped its vow to increase bond buying if needed, a sign it might begin to shift its tone as it prepares to exit its own quantitative easing program.
No moving targets
The BOJ's main policy is "yield curve control," which seeks to guide short-term rates to minus 0.1 percent and the 10-year Japanese government bond yield to zero. This current monetary framework with the 10-year JGB yield as a policy target makes it difficult for the BOJ to give forward guidance. If it were ever to set a new target, the market would instantly react--and such action would likely bring great volatility to the JGB market.
Theoretically, the bank could gradually move its target rate, but that would set up the market to keep testing the BOJ, and in turn it would likely have to buy more and more JGBs to keep the yield around its target. Ironically, such a move intended to normalize policy could in effect lead to more easing, in the form of additional JGB purchases.
The BOJ is already doing what some call "stealth tapering," in that it is already shrinking the amount of its JGB purchase operations. Last year, it purchased roughly 56 trillion yen of JGBs (on a net basis), compared with its loose target of 80 trillion yen a year set forth in its monetary policy statements. In September 2016, it abandoned its former explicit goal of increasing base money supply by 80 trillion yen a year.
Three reasons for pause
There are three main reasons the central bank cannot do more at this time. First, the BOJ has doggedly stuck to its stated two percent inflation target, which has not yet been achieved. The bank forecasts it will reach its 2 percent goal in the fiscal year ending in March 2020, though most economists believe that this is unlikely.
Currency is another reason. Markets have been speculating a lot about what the BOJ might do this year, which has helped the yen appreciate to around 105 yen per US dollar now, with the potential to strengthen even further. Even after this year's yen gains, yen-short positions remain. If the BOJ mismanages its communication to the FX market and investors unwind those positions, this could lead to even more yen appreciation.
Third, the BOJ does not want to risk doing anything that could potentially have a negative impact on the macroeconomy, particularly now that it might face headwinds, including the possibility of slowing growth in China and trade friction with the United States. The Japanese economy has grown for eight consecutive quarters, the longest streak in 28 years, backed by favourable external conditions.
Against this backdrop of economic improvement, the prolonged easy policy is squeezing bank's profit margins. Still, the BOJ has shown no inclination that it is gearing up to join other major central banks in normalizing policy.
For investors, all of this means a need to pay extra attention to currency market fluctuations and bracing for the possibility of further yen appreciation, which would work against the BOJ's progress toward its inflation goals. Investors will also be keen to see the details of discussions among the BOJ board members for insights on the thinking of Kuroda’s two new Deputy Governors: Masazumi Wakatabe, an academic known as an advocate of aggressive easing, and career central banker Masayoshi Amamiya.
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