31 October 2019
Super-low interest rates pressure financial sector
The BOJ maintained its short-term interest rate target at -0.1 per cent and continued its pledge to guide 10-year Japanese government bond (JGB) yields to around zero per cent, by a 7-2 vote. Its policy statement contained new language underscoring its resolve to keep rates as low as it deems necessary."
The BOJ expects short- and long-term interest rates to remain at present or lower levels as long as needed to pay close attention to the possibility that the momentum toward achieving its price target will be lost," the statement said, compared to the BOJ’s previous commitment to keep "current ultra-low rates for an extended period of time, at least until the spring of 2020".
Japan’s economy faces both internal and external challenges. This month’s hike to the national sales tax threatens to drag down consumer spending at home, while global growth faces hurdles and US-China trade tensions persist. Interest rates are already in negative territory, so options for further monetary easing are limited. Deeper cuts into negative territory would have taken a steep toll on Japan’s financial institutions, particularly regional banks, which are already feeling the pinch of the country’s super-low interest rate environment.
BOJ doesn’t want long-term rates to fall further
Ahead of the latest meeting, BOJ Governor Haruhiko Kuroda also signaled in a media interview earlier this month that a cut to the short-term policy rate was definitely an option for additional easing, though he said he didn’t want long-term rates to fall further. This implied that the BOJ might be gearing up to cut the -0.1 per cent policy rate but at the same time take measures to mitigate the side effects of that step, including reducing 20-year and 30-year JGB purchases, or expanding the basic balance of the BOJ’s current account. Kuroda’s comments, followed by some reduction of JGB buying in those sectors in the bank’s regular purchase operations, helped lift the 30-year JGB yield relative to the 30-year US Treasury yield.
Chart 1: BOJ hopes to keep long-term JGB yields roughly aligned with US Treasury yields
Waning expectations of inflation
The BOJ on Thursday also trimmed its inflation expectations in its quarterly forecast. It now expects core consumer price inflation of just 0.5 per cent, excluding the impact of the sales tax hike, in the fiscal year through March 2020, and 1.0 per cent in the following fiscal year, down from forecasts of 0.8 per cent and 1.2 per cent, respectively.
While the revisions could lay the groundwork for additional easing measures ahead, we do not read too much into the lower growth/inflation forecasts, as the BOJ’s intent was likely to make the forecasts conform with market views. The BOJ has no timeline to meet its target of 2 per cent inflation, as core consumer inflation remains stubbornly low: the latest reading of 0.3 per cent in September was the lowest since April 2017.
Other central banks face the same delicate balance of whether to further ease now or hold fire and save some ammunition to counter future crises. Just a day before the BOJ’s latest decision, the U.S. Federal Reserve cut interest rates for the third time this year to support growth but signaled no further cuts would be forthcoming. Last week, the European Central Bank held its interest rates steady at historic lows and kept its forward guidance unchanged, after pushing rates deeper into negative territory and starting an open-ended bond purchase program at its previous meeting in September.
Future BOJ action is subject to domestic and global macroeconomic trends as well as other key central banks’ actions, and where the yen is trading. For now, with markets still basking in the rising optimism over US-China trade disputes and fewer apparent risks of a US recession risks, the BOJ is like to likely to stand pat at its next monetary policy meeting in December.
However, improving global macro-economic conditions wouldn’t solve the BOJ’s most crucial problem: a lack of effective easing tools to boost inflation and growth without further hurting the domestic financial system already groaning from the impact of negative rates. While the BOJ signaled its readiness to take additional easing measures if needed, if it continues to slash its inflation forecasts without any real actions, the central bank might face another problem - how to maintain market confidence in its future actions.
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