Business / Economy | ANALYSIS

BOJ seen in uphill battle to control long-term rates as U.S. yields climb

by Tomoyuki Tachikawa

Kyodo

America’s economic and monetary policies are likely to become a headache for the Bank of Japan now that it is trying keep the yield on the 10-year Japanese government bond at around zero percent.

Although Japan’s long-term interest rates were negative earlier this year, they have since turned positive in tandem with climbing U.S. Treasury yields after Republican Donald Trump’s victory in the Nov. 8 presidential election and the Federal Reserve’s first rate hike in a year this past Wednesday.

The BOJ is set to stand pat at its two-day policy meeting through Tuesday, the first since Trump’s win. But market participants are paying close attention to whether the central bank will give hints on how it will deal with rises in long-term interest rates.

U.S. Treasury yields have been on an upward trend amid growing speculation the Trump administration may bolster government spending and issue more bonds, which will likely generate higher inflation in the United States.

In addition, mounting expectations that the pace of the U.S. central bank’s rate hikes will be faster than predicted have provided impetus to Treasury yield rises. The 10-year yields briefly soared to 2.64 percent Thursday, hitting their highest since September 2014.

Long-term interest rates have also climbed in Japan. The yield on 10-year JGBs rose to 0.100 percent Friday at one point, its highest since the BOJ decided to adopt a negative interest rate policy in late January.

The bank may maintain efforts to control the 10-year yield to ensure the “credibility” of its policy, said Naohiko Baba, chief economist at Goldman Sachs Japan Co.

To curb sharp rises in long-term yields, the central bank last week boosted purchases of JGBs from the market for the first time since it switched its policy target in September to the yield curve from quantitative easing. Yields move inversely to debt prices.

“If the U.S. long-term yield continues heading upward toward 3 percent, we think the BOJ would find it increasingly difficult to control the 10-year yield,” Baba said.

Many BOJ watchers echoed that view, saying the bank may not be able to keep buying government debt at the same pace as before. It has already gobbled up about 40 percent of the nation’s outstanding JGBs of more than ¥1 quadrillion ($8.48 billion), as it has pledged to buy ¥80 trillion of them per year.

“The BOJ can control interest rates because it can buy any amount of government bonds when needed,” said Kazuo Momma, a former BOJ executive director who is now executive economist at Mizuho Research Institute.

Takuji Aida, chief economist at Societe Generale Securities, argues that a possible shortage of JGBs to buy from the market would become a “deep issue” for the BOJ.

To deal with the supply issue, the central bank is expected to be forced to raise its target yield level from the current zero percent to around 0.4 percent in late 2018 by decreasing the pace of debt purchases, Aida said.

As for the BOJ’s pursuit of its inflation target, domestic prices are likely to move out of negative territory soon. An upturn in global oil prices and a stronger U.S. dollar against the yen, triggered by rises in Treasury yields, are set to drive up import prices in Japan, which depends on imports for over 90 percent of its energy needs.

The yen’s depreciation would also support Japan’s export-oriented economy by making Japanese products cheaper abroad while increasing the value of overseas revenue in yen terms, contributing to inflation at home.

The BOJ’s quarterly tankan survey, released Wednesday, showed business sentiment at large manufacturers improved for the first time in six quarters in December.

“Consumer prices have shown no signs of falling further,” said Takeshi Minami, chief economist at the Norinchukin Research Institute, adding that inflation, caused by economic growth, could allow the BOJ to phase out its government debt buying.

One concern is that a surge in interest rates would drag down domestic demand, with mortgage rates and corporate borrowing costs increasing. An economic slowdown could make it difficult for the central bank to achieve its 2 percent inflation goal.

“If higher long-term interest rates reduce the momentum toward 2 percent inflation, we may boost purchases (of government bonds) to lower (the 10-year yield) to around zero,” BOJ Deputy Gov. Kikuo Iwata said earlier this month.

According to one senior BOJ official, “It is uncertain whether the BOJ can prevent a spike in long-term interest rates by expanding government debt buying, given the outlook of the bond market.

“The BOJ’s monetary policy has bogged down,” he added.

Japan’s consumer prices in October fell 0.4 percent from the previous year, down for the eighth consecutive month, though the pace of decline was slower than in September, government data showed late last month.

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