The Bank of Japan faces a “terrifying dilemma” in which inflation could force it to tighten monetary policy at a time when the central bank needs to support the bond market the most, according to a former board member.
There’s about a 50 percent chance the BOJ will achieve its 2 percent goal for consumer-price increases, which could push the 10-year yield above 3 percent, said Kazuo Ueda, who served as a BOJ policymaker from 1998 to 2005 and was also senior adviser to the Government Pension Investment Fund.
Bond market expectations for inflation have risen to 1.36 percent from 0.94 percent in October, data compiled by Bloomberg show.
“If the 2 percent inflation goal becomes imminent, the BOJ should be tightening policy rather than loosening,” Ueda, who is now a professor of economics at the University of Tokyo, said last week. “That means that we will face a terrifying dilemma that the central bank won’t be able to increase JGB (Japanese government bonds) buying to support the bond market.”
The BOJ’s unprecedented stimulus program, under which it buys about ¥7 trillion of sovereign bonds a month, helps keep borrowing costs for the world’s heaviest debt ratio at the lowest globally. Gov. Haruhiko Kuroda indicated on April 23 that the central bank won’t buy bonds just to keep down debt-servicing costs after achieving its inflation goal.
Six of the 28 economists surveyed by Bloomberg from May 2 to May 8 said the BOJ will start tapering in 2016.
Investors who bought the 10-year bonds Tuesday, with yields at 0.61 percent would lose 8 percent if the benchmark rate were to rise to 3 percent by the end of fiscal 2015, when the BOJ projects the inflation target will be met, according to data compiled by Bloomberg. The 10-year yield reached 0.57 percent on March 3, the lowest in a year.
“Current nominal yields show the inflation expectation in the bond market is dead,” said Ueda, whose role as the head of the investment committee for the world’s largest pension fund ended last month. “What’s scary about this is that once it becomes clear to everyone that prices will start rising, there’s a risk that bonds will be heavily sold off.”
The 10-year break-even rate, derived from the difference between yields on conventional and index-linked bonds, rose to 1.37 percentage point on April 30, the highest close since the government resumed selling 10-year linkers in October. Consumer prices excluding fresh food have been at a five-year high of 1.3 percent since December.
There is little sign of distress in the market. Credit-default swaps that insure Japan’s sovereign debt against default for five years fell to 42.5 basis points Tuesday, according to data provider CMA.
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