Since becoming the Bank of Japan’s governor this month, Kazuo Ueda has carefully signalled policy continuity. Few investors are taking his words at face value.
With the first change in BoJ governorship in a decade, a break in bank tradition with an academic at the helm and inflation at a multi-decade high, the stage is set for change.
Ueda’s first policy board meeting, which kicked off on Thursday, will offer crucial clues as to whether the 71-year-old economist is really committed to the status quo or laying the groundwork to unravel Japan’s ultra-loose monetary policy regime.
Any change in policy will have huge implications for capital markets accustomed to the bank’s massive bond purchases and interventions to try to control interest rates. The immediate concern for investors is whether the BoJ will further revise or abandon yield curve control, a policy it pioneered in 2016 to cap rates on the benchmark 10-year Japanese government bonds at about zero per cent.
Most economists expect Ueda to hold off on changing the YCC framework until the summer, although he may surprise investors by scrapping it immediately while speculative pressure on Japanese bonds remains low.
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A bigger question that will govern Ueda’s five-year term is whether the central bank is on the cusp of finally achieving its 2 per cent inflation target as prices and wages rise.
If there is enough certainty to reach the target, Ueda has already signalled he would aim to unwind extreme policy tools deployed over the past decade that have expanded the BoJ’s balance sheet to 120 per cent of Japan’s gross domestic product.
“At the moment trend inflation is below 2 per cent, so we will continue monetary easing,” Ueda told parliament this week. “If it is projected to reach 2 per cent, then we will head towards normalisation. We will scrutinise even more closely so that we will not make a wrong judgment on the inflation outlook.”
Analysts warn that any exit strategy would require the BoJ and the government to address a daunting list of issues before Ueda can actually implement it without destabilising global financial markets.
“Dealing with the aftermath of quantitative and qualitative monetary easing will be costly, and it will be an extremely difficult balancing act,” said Ayako Fujita, chief Japan economist at JPMorgan Securities.
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If Ueda revises or ditches YCC in the coming months, the BoJ is then expected to review negative interest rates, which Japan is alone in maintaining.
But removing the deposit rate of -0.1 per cent is also expected to be a slow process given the potential impact on the stock of floating-rate household mortgage debt that has mounted since the policy was introduced in 2016.
The massive asset purchase programme under Ueda’s predecessor Haruhiko Kuroda has also left the BoJ owning more than half of Japan’s government bonds and locally listed exchange traded fund assets.
The paper losses for its bond holdings will increase substantially as interest rates rise, but these are unlikely to translate into realised losses since the bonds can be held to maturity.
ETFs, on the other hand, do not mature so the BoJ, now the biggest investor in Japanese stocks, faces a hit if shares decline sharply. Despite raising its target for annual ETF purchases to ¥12tn ($90bn) in 2020 to support the economy during the pandemic, the BoJ has significantly scaled back the buying and has acquired ¥140bn this year.
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“As an ETF exit strategy has the potential to destabilise the stock market, the BoJ is likely to treat it with special care, and the start of full-fledged discussions on this issue may not get under way until well into governor Ueda’s term,” Naohiko Baba, Japan economist at Goldman Sachs, wrote in a report.
Another major risk factor is a potential recession in the US if inflation remains high and the Federal Reserve goes back to raising rates aggressively, which would once again put selling pressure on the yen.
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A spillover slowdown of the Japanese economy could kill inflation momentum, just as prices rises have started to broaden beyond the boost in imported energy costs caused by the war in Ukraine.
In March, so-called core-core consumer prices, excluding all food and energy, rose 2.3 per cent, throwing doubt on the BoJ’s argument that inflation is not driven by underlying consumer demand and is likely to fall below its target later this year.
“We’re starting to say this time may be different,” said UBS economist Masamichi Adachi, citing bigger than expected salary increases agreed by large companies and businesses’ willingness to raise prices to reflect increased costs. “But we’re not yet in a position where we can confidently say that this time is different.”
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