BOJ: Major Changes in 2018

Published on November 28, 2017

Speculation over the course of the Bank of Japan’s massive bond purchases and ultra-easy monetary policy next year is inevitably intertwined now with questions over the re-appointment of BOJ Governor Haruhiko Kuroda when his term expires on April 8 of 2018. 

Prime Minister Shinzo Abe has repeatedly expressed appreciation and support for Kuroda, and for the Governor’s aggressive policy style that helped finally jolt Japan out of years of deflationary expectations and outright deflation, including in front of Parliament as recently as today.  

*** But from what we understand, Abe is considering the need for a BOJ leadership transition, albeit in a face-saving way. When the time comes, we believe Abe may re-appoint Kuroda, but with the understanding that Kuroda would then step aside and make way for a new nominee. *** 

*** That would allow the Prime Minister to pay his respects to a Governor who has been hugely successful by any number of measures, but then install new leadership, with Kuroda’s implicit blessing. A new governor could then scrap or more likely revise the Bank of Japan’s formal 2% inflation target for something equally aggressive, but perhaps more readily attainable. Note the specific inflation measure targeted has been changed from the original already, from headline to core, to the BOJ’s own constructed measurement of “core-core.” *** 

Kuroda was not only the architect of the central bank’s enormous QE program that evolved into the “Yield Curve Control” policy, but he was, of course, also instrumental during the early years of his term in pushing a formal 2% inflation target through the BOJ.  

That target was controversial from the outset, and has proven elusive to hit since. 

A Re-Assessment in Zurich 

One would be remiss though to interpret any efforts to potentially revise BOJ policy now as a reflection of a re-think of the merits overall of ultra-easy monetary policy conditions for Japan’s aging, high savings, low inflation economy.  

It is, nevertheless, an acknowledgement of the increasingly distortive side effects of additional marginal BOJ purchases and ownership of Japan’s bond markets over the financial sector, and perhaps even, in a negative way, on expectations writ large.

Speculation over the future pace of BOJ bond purchases was raised most recently on November 13 by Kuroda himself, in a speech delivered at the University of Zurich with the dry, but all-encompassing, title of “Quantitative and Qualitative Monetary Easing and Economic Theory.”

What especially caught the markets’ and analysts’ attention in that speech was an acknowledgement by Kuroda of the potential negative impact of the BOJ’s current policy course on Japan’s banking sector.  

That included the potential risk of what is being called “the reversal rate,” namely the increasingly negative impact on financial intermediaries and feedback loop into the real economy were the central bank to drop – or keep – interest rates too low, for too long.

To dispel any notion the BOJ is about to hike, or more accurately, substantially step back from its ultra-aggressive bond purchases, anytime soon, Kuroda did clarify before parliament today that this “reversal” is not currently yet the case.

But if the central bank were to go too far with low rates, the concern is, the banking sector’s capital could be increasingly constrained through continued pressure on net interest margins, impairing the ability of the financial markets to function in their roles as proper economic intermediaries.

The effect of monetary easing on the economy would at that point turn contractionary and reverse, and, because the impact of low interest margins on the soundness of financial institutions is deemed to be cumulative, the BOJ would then need to pay attention to that risk as well.

Challenging the Program and Targets

In reality, Japanese banks, and especially local banks, have plenty of factors to blame for margin and profitability pressures besides low rates, including the deterioration of regional economic conditions, and declining populations in rural areas.

But Kuroda’s speech did flag some increasing concerns over local banks, and with it implied a potential revision to future BOJ monetary policy.

And already, in October’s BOJ Monetary Policy Meeting, some members were said to have expressed concerns that if the Bank were to take extreme measures for the sole purpose of hastening the achievement of the 2% objective, “side effects such as an accumulation of financial imbalances and an impaired functioning of financial intermediation could arise.” That, and other such comments, represent a clear distancing by Board members from the hard 2% target that is still owned by Kuroda, but at this point, by precious few others save a dovish dissenter on the Board.

In addition, the ultimate impact or desirability of continued purchases by the BOJ of equity ETFs is increasingly being questioned, both within and outside the BOJ, and all the more so as global equity markets continue to rise. 

Still, all said, the BOJ is unlikely to institute any major changes in the (very) near term. But Kuroda may well be paving the way for just such changes, by a new governor, when his term ends in April of next year.

Indeed, in stating his support today for Kuroda and his policies, including seeing no need to change the joint statement of 2013 by the government and BOJ committing respectively to fiscal and structural policies and a 2% inflation target, Abe was careful to add the qualifier “for now.”

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