When the Bank of Japan holds its next regularly scheduled Monetary Policy Meeting on March 18 and 19, all eyes will be on the release of its long-awaited monetary policy review for signs of potential or real shifts in the central bank’s monetary policy, strategy, and asset purchase programs.
While the review is not expected to result in any major shifts in policy objectives or the tools used to execute those policies, we believe it is still likely to result in some adjustments that will be of great interest to markets:
1 – Expansion of the 10-year JGB band guidance.
As we flagged just under a month ago, (see SGH 1/20/2021; “BOJ: Positioning for Steeper H2 Curve”), we believe the Bank of Japan is more than likely to expand the band within which it allows the 10-year JGB to trade by ten basis points on each side, from plus or minus 0.2% around 0.0%, to plus or minus 0.3%.
While symmetrically widening the JGB trading band is, technically speaking, a neutral policy signal, and will be presented as such, the real purpose behind the additional flexibility seems more one-sided. Namely, it is to adjust and loosen the BOJ’s yield curve control band in anticipation of an H2 2021 recovery in the Japanese economy, and a possible further steepening now as well in the US Treasury yield curve, which is expected will exert some more natural upside pressure on JGB yields as well.
A nod towards allowing a modestly steeper yield curve will, of course, also help boost the profitability of Japan’s banking industry, kept down for years by the prolonged, ultra-low interest rate environment.
2 – More flexibility in ETF purchases
The calls on and from what we understand even within the BOJ have been mounting to adjust the scale of its equity ETF purchases linked to the Nikkei and Topix indices as Japanese stock markets hit highs not seen for a generation.
We expect the policy review is likely to add some additional flexibility to the BOJ ETF program to enable the central bank to reduce its purchases when markets are high, or rising steeply, and to increase them when they are low, albeit without committing to any specific price levels or metrics.
At current levels, that would translate into a greater tolerance on the downside, and intriguingly, the buzz in Tokyo is that the central bank may have been testing markets already for their reaction to that added flexibility in its ETF purchase program last night.
At the close of the morning session yesterday, the TOPIX index was down by 0.54% from the previous day’s close. That drop of over 0.5% would normally have triggered a BOJ intervention in the equity markets, but our understanding is that while they did eventually conduct more purchases, they refrained from stepping in at that level – the first time, if confirmed, that they have not stepped in after a 0.5% drop since March of 2016.
Perhaps not surprisingly, Japanese equity markets continued to fall in the afternoon to close down by around 1%, in large part on suspicions that the BOJ might indeed be quietly testing out a more flexible ETF purchase program ahead of the March policy review.
That, of course, opens the question to a bigger debate over the appropriate level, and whether to adjust, the BOJ’s long-standing overall annual target of 6 trillion (and up to 12 trillion) yen in ETF purchases per year.
And truth be told, many of the key personnel within the BOJ already consider that level of central bank ETF purchases to be inappropriate under current market and economic conditions. But as with their colleagues at other major central banks, BOJ officials will seek to avoid any signal that they might be scaling asset purchases on any significant level, and in the process prematurely reducing the pace and scale of accommodation into the system.
So while an adjustment in the overall target level, in addition to greater two-way flexibility in execution, would make a lot of sense, it will depend on how markets and the economy are behaving in a month’s time, and we suspect an outright target adjustment will be seen as a premature and overly hawkish signal, even as trial balloons soften up expectations for changes to the ETF program over the coming weeks.
We suspect the true exit from ETF purchases will not come into focus until next year, in 2022. As opposed to bond purchases, there is no maturity or natural roll-off for these equity instruments, so the BOJ will need at some point to actively sell these back into the markets.
At that point, traders may wish to dust off the proposals put forth by Shigeki Kushida, who as head of the BOJ’s powerful Monetary Affairs Department back in October of 2010, when the central bank first started its equity purchase program, suggested that when the time comes, the BOJ could gradually place its equity holdings directly with the public, and not straight into the markets.
3 – Deeper negative rates on bank reserves
On February 10, Japan’s Jiji Press and Bloomberg News reported that the BOJ is considering whether to charge an even deeper negative rate on bank reserves that are on deposit at the central bank. We, and most BOJ watchers, seriously doubt they will actually do that.
While the BOJ, like other central banks who have delved into negative rates territory, will remain keen to communicate that it has not hit the “lower bound,” or “reversal rate” as is the preferred nomenclature in Japan, on negative rates, at this point most objective economists would assert that more negative interest rates would have almost no positive impact on the economy, and rather continue to hurt the financial health of Japan’s private banks, especially the local banks.
To that, the BOJ in fact just offered, in November of 2020, a non-negative (plus 0.1%) interest rate on reserves held by local banks and smaller financial institutions that could submit plans to improve on their profitability or indicate an interest in merging with other local banks.
4 – Review of targets
As to any changes to the broader BOJ strategy and targets, Governor Haruhiko Kuroda made clear at his press conference after the December 18, 2020 Monetary Policy Meeting that there would be no change to the framework of monetary policy easing, nor to its commitment to a 2% inflation target at the upcoming review in March.
That message of continuity was further reinforced today after a meeting with Prime Minister Yoshihide Suga, where Kuroda was reported to have stressed that any changes would be made solely to make easy policies more effective and sustainable over the long run, and not to signal the removal of any accommodation.
But the key point for markets is that when the goal is to maintain accommodative conditions, what that means in practice when economic and financial conditions are improving is that the central bank can take its foot ever so slightly off the accelerator, and yet still “maintain” an equal, relatively speaking, level of accommodation in the system.