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BOJ’s success may hinge on fate of ‘kamikaze’ Trump rally

Kyodo

The Bank of Japan, which has given up on achieving its 2 percent inflation goal by printing more money, is expected to fret over the fate of the “Trump rally” in 2017.

If U.S. Treasury yields continue to rise and the dollar extends gains against the yen, the BOJ might begin tapering its aggressive monetary easing. But once the yen turns upward, the central bank could be forced to implement additional easing once again, just like it’s done for the past several years.

“The BOJ wants to carefully assess sustainability of the rise in U.S. interest rates and the yen’s weakening trend since the U.S. presidential election,” said Naohiko Baba, chief economist at Goldman Sachs Japan Co.

2016 was turbulent for the BOJ. The central bank decided in January to apply a negative interest rate of 0.1 percent on some reserves held by commercial banks. In September, the bank shifted its policy target to “yield curve control” instead of boosting asset purchases.

At its two-day policy meeting through Dec. 20, the first since the U.S. election, the BOJ kept its 10-year government debt yield target unchanged at around zero percent, as well as its negative interest rate policy.

BOJ Gov. Haruhiko Kuroda denied the possibility of raising the yield target anytime soon, despite the continued rise of long-term interest rates after Republican Donald Trump’s victory.

“Promoting powerful monetary easing under the current policy is most appropriate” for now to realize 2 percent inflation, Kuroda said at a news conference after the meeting.

Should the BOJ successfully curb increases in government bond yields, the wider interest rate gap between Japan and the United States would weaken the yen further against the dollar, as the Federal Reserve is set to continue tightening monetary policy in line with economic recovery.

Expectations for Trump’s economic policies, centering on infrastructure spending and tax cuts, may also pump up stock prices, slashing demand for U.S. Treasuries and sending yields higher. Debt prices move inversely to yields.

A falling yen would push up import prices in Japan, which could help the BOJ attain its inflation goal, although core consumer prices, excluding volatile fresh food prices, were mostly stuck in negative territory during 2016.

“Gov. Kuroda must be feeling ‘Yay!’ as he has been waiting for this opportunity,” said Hajime Takata, chief economist at the Mizuho Research Institute.

Takata added that if the “lucky situation” continues, the BOJ may raise its 10-year bond yield target — a tapering process for its massive asset buying that has often been criticized as impairing the functioning of financial markets.

Daiju Aoki, an economist at UBS Group AG, echoed that view.

“We think it’s likely the central bank will start to taper (in 2017). This is because the pool of outstanding Japanese government bonds for the BOJ to purchase is rapidly declining,” Aoki said.

The BOJ already owns around 40 percent of Japan’s outstanding government bonds, or more than ¥1 quadrillion ($8.50 trillion), and is buying ¥80 trillion of them per year.

At the December meeting, BOJ Policy Board member Takahide Kiuchi said the yield curve control policy “would entail a risk that the bank might need to further increase the pace of its Japanese government bond purchases.”

Some analysts emphasized the importance of the BOJ raising the key bond yield target, which is often dubbed a “rate hike,” pointing out that sharp rises in import costs, triggered by a rebound in crude oil prices and the yen’s plunge, could eat into corporate profits and hurt consumers’ purchasing power.

“To warn against an excessive depreciation of the yen, the BOJ would be urged to carry out a rate hike,” said Junichi Makino, a BOJ watcher at SMBC Nikko Securities Inc.

Such concerns, however, will disappear if the Trump rally peters out.

“If the kamikaze stops blowing, inflation would cool down,” said Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities.

BOJ policymakers have voiced fears about the risk, citing the uncertainty over the U.S. economy, which is to be handled by Trump, who has no political experience.

“The U.S. economic measures exert great influence not only within the country but also on the global economy and global financial markets, therefore, the new administration’s policy directions and their influence warrant close attention,” BOJ Deputy Gov. Kikuo Iwata said in early December.

Market turmoil could prompt many investors to sell riskier assets, including stocks and crude oil futures, and buy safe-haven assets such as government debt and the yen.

A stronger yen usually weighs on Japan’s export-oriented economy by making Japanese products more expensive abroad and reduces the value of overseas revenues in yen term.

Iwata said the BOJ “will take additional easing measures without hesitation” if necessary.

As a step to make financial market conditions more accommodative to stimulate the economy, Kuroda has indicated the central bank may deepen a key negative interest rate or cut the target level of the 10-year government bond yield.

But a BOJ official said, “We can’t say we have adequate policy options to deal with contingencies. We wish Trump good luck.”