The Bank of Japan made seemingly moderate adjustments to the monetary easing policy framework at its monetary policy meeting of July 30-31 and even described the adjustments as a “strengthening” of the framework with an adoption of the forward guidance on policy rates.
The 10-year bond yield has begun to exceed 0.12 percent from the following day, but so far the BOJ successfully avoided a sharp stock fall and a sharp appreciation of the yen — suggesting that the market did not view these adjustments as a less dovish stance. In fact, the BOJ skillfully introduced a few elements that could lead to steps toward normalization of Japan’s monetary policy.
First, the BOJ introduced the 10-year “target range” of plus and minus 0.2 percent (-0.2 percent to +0.2 percent) from the previous target range of plus and minus 0.1 percent. The new target range was mentioned by BOJ Gov. Haruhiko Kuroda at a press conference on Tuesday, while the previous target range used to be inferred by market participants through the levels of fixed rates chosen by the BOJ in conducting unlimited bond purchase operations.
In practice, this range means from 0 percent to 0.2 percent because negative 10-year yields are highly unlikely due to the scarcity of Japanese Government Bonds (JGBs) as a result of the BOJ’s massive holdings. This is consistent with my view as I have long advocated the adoption of the 0-0.25 percent target range. This is clearly a step toward normalization.
How did the BOJ manage that? The central bank did not mention anything about the adoption of a wider yield target range in its statement on monetary policy; instead, Kuroda indicated it in a light manner at the press conference. This gives the impression that the BOJ did not change the 10-year yield.
Moreover, the forward guidance on policy rates was a vague expression because no commitment was made to the continuation of low rates at least until October 2019 (when the consumption tax hike is scheduled) as well as to the specific levels of the 10-year yield.
At the press conference, Kuroda did not make these points clear, either. Therefore, it is still possible for the BOJ to raise the 10-year yield target range above 0.2 percent in the foreseeable future if favorable economic and market conditions prevail.
Second, Kuroda stressed that a widening of the yield target level was to improve the functioning of the JGB market (i.e., the lack of trading) — not to cope with side effects on financial institutions. In reality, however, a moderately higher yields of longer-term bonds will help insurance firms and regional banks. Moreover, the BOJ will reduce the amount of current account balances to which a negative interest rate is applied from the current ¥10 trillion on average.
These moves are a clear indication of the BOJ’s concerns about the adverse impact of a yield curve control. The central bank may be hesitant to admit it to avoid further calls from the financial sector to raise policy rates.
Third, the BOJ will purchase exchange-traded funds (ETFs) more flexibly by buying more when sharp falls occur and less when mild falls take place. While the BOJ stressed that the annual purchase amount of about ¥6 trillion is maintained, this may lead to “stealth tapering” as is the case of the JGBs. Also, increasing TOPIX-related ETF purchases is a good move because of less distortions generated on small-cap stock prices included in the Nikkei 225.
Therefore, the intention of the BOJ’s adjustments is not only to improve the sustainability of the framework (as stressed by the central bank) but also to leave room for further steps toward normalization. The BOJ needs to raise the 10-year yield further in the near future given that the upper limit of 0.2 percent remains too low.
The ambiguity and complexity of the monetary policy framework began in January 2016 when the central bank announced a complicated three-layered system on a negative interest rate. The central bank is unlikely to make any new moves for the time being until the markets get accustomed to the adjustments. Thus, determining whether the BOJ’s action was just a tweak requires further investigation.
Sayuri Shirai is a professor of economics at Keio University and a former board member of the Bank of Japan. She is the author of “Mission Incomplete: Reflating Japan’s Economy.”