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BOJ dilemma: Stabilize bond market or stick to QE guns?

by Mie Sakamoto

Kyodo

The Bank of Japan faces a dilemma: Should it take additional steps to stabilize turbulent financial markets or resolutely avoid a piecemeal approach to fulfilling its pledge to beat deflation with radical monetary easing?

The BOJ disappointed the markets on Tuesday by deciding not to adopt new measures to contain spiking yields in government bonds.

Afterward, BOJ Gov. Haruhiko Kuroda, in an apparent show of determination against makeshift responses to market confusion, stated that markets are expected to calm gradually as the economy recovers.

“The BOJ is believed to have placed more emphasis on the predictability of its policy by sticking to its stance of not taking a piecemeal approach, rather than seeking the flexibility” preferred by Kuroda’s predecessor, Masaaki Shirakawa, said Yuichiro Nagai, an economist at Barclays Securities Japan Ltd.

When the BOJ announced bold monetary steps on April 4 centering on doubling the nation’s monetary base and boosting bond purchases across all maturity levels, Kuroda said that the BOJ had taken “all the necessary measures” at that point to achieve his 2 percent inflation target within around two years.

The bank will put an end to adopting measures incrementally, he declared.

The central bank’s decision to opt for inaction “invited substantial falls in stock prices,” Nagai said. “Announcing that the BOJ did everything that was necessary raised the predictability of the policy outlook. But such a stance made it difficult to balance predictability with flexibility when conducting monetary policy.”

The BOJ’s monetary easing policy is one of the three “arrows” of Prime Minister Shinzo Abe’s “Abenomics” program for economic recovery. The other two are flexible fiscal spending and growth strategies.

The unprecedented easing steps, which also involve the expansion of BOJ purchases of such risky financial assets as exchange-traded funds and real estate investment trusts, helped weaken the yen sharply and reinflate the stock market.

But the dollar, which climbed to as high as the ¥103 range in May, has given up all its gains since April 4 and dropped below the ¥94 line on Thursday.

The benchmark Nikkei stock index is also tumbling down toward pre-easing levels; it has retreated more than 20 percent from its five-year, five-month high of 15,627.26 logged May 22.

The yield on the bellwether 10-year government bond briefly spiked to 1 percent on March 23, as financial institutions moved to trim their bond holdings, apparently over instability concerns generated by the BOJ’s massive bond buying, which is reducing liquidity in the JGB market.

The yield appears likely to stabilize around 0.8 percent, but remains higher than the all-time low of 0.315 percent logged after the BOJ announced radical easing steps intended to keep interest rates low.

Despite the unfavorable developments, the government is attempting to remain confident about the economy’s prospects, citing brighter economic data.

“We have absolute confidence in Gov. Kuroda’s monetary policy, so we expect (the BOJ) to take appropriate steps by looking at various developments,” Chief Cabinet Secretary Yoshihide Suga said at a news conference Thursday.

At a government meeting Thursday, Kuroda said the stock swoon was caused by investors taking money off the table amid speculation that the U.S. Federal Reserve might move to scale back its quantitative easing program amid the meteoric rise of the Nikkei, a government official said.

Financial markets “are likely to restore calmness gradually, reflecting positive developments in the real economy,” Kuroda said, adding that overseas factors were behind the recent volatility.

While some market participants are calling on the central bank to take additional steps to reduce the volatility, Koya Miyamae, an economist at SMBC Nikko Securities Inc., said the BOJ should refrain from adopting unnecessary measures whenever markets urge it to do so.

“We’re not in a financial crisis. The economy is recovering,” Miyamae said, adding that taking an incremental approach will limit the BOJ’s leeway to take effective steps when really needed.

Taking further easing steps, such as buying more JGBs, would stir concern that the BOJ is monetizing the debt, which would produce even greater instability, Miyamae said.