As Kuroda bows out, Bank of Japan’s rising hawks eye end to unloved yield cap

By Dan Neff On Dec 16, 2022

TOKYO – As Haruhiko Kuroda’s decade helming Japan’s central bank nears an end, more of his senior colleagues are seeing a case to remove the bank’s cap on bond yields, a key but problematic piece of his radical monetary stimulus.

The rare hawkish shift inside the Bank of Japan (BOJ) comes after years of heavy money printing failed to fire up anemic consumer demand and amid growing anger about the impact of ultra-low interest rates on bank lending margins and, more recently, the cost of living.

A dozen people familiar with the BOJ’s thinking say debate over how to remove a controversial cap on bond yields, introduced in 2016 as part of the bank’s yield curve control (YCC) programme, could gather pace next year, provided wages perk up and major economic risks remain contained.

While no detailed discussions of a policy change are under way yet, the preference of many within the BOJ is to completely remove the yield cap altogether, the sources said.

That would be much bolder than what the market currently thinks the BOJ’s next move will be – a widening of the tolerance band around the cap for the 10-year government bond yield.

Any visible shift in BOJ thinking, even if it doesn’t lead to an immediate monetary setting change, could trigger massive selling in Japanese bonds, which would have significant implications for global markets.

“Widening the band will only fuel speculation of a future rate hike and trigger a bond sell-off, rather than help address the side-effects of the yield cap,” one of the sources said, a view echoed by two other sources.

“There’s near consensus within the BOJ that if it were to tweak YCC one day, the best step would be to ditch the cap,” another source said.

The sources spoke on condition of anonymity as they are not authorised to speak publicly.

Public discontent

After a tumultuous year for the world’s third-largest economy, Japan’s central bank and its leadership face a critical moment.

Consumer inflation is at a four-decade high and finally above the BOJ’s elusive 2 percent target – but not because households are cashed up and buying more.

In addition to global supply pressures caused by the Ukraine war and the pandemic, the collapse in the yen has fanned a surge in costs of imported raw materials and ultimately household goods, making Kuroda and his currency-weakening low interest rates targets of public outrage.

“Everything in the supermarket has seen prices rise,” according to 84-year-old pensioner Yoshio Koitabashi, who says he can’t afford to buy a refrigerator, despite saving every penny when shopping for food.

“They aren’t thinking about those who are weak,” he said of the BOJ. “They are doing everything for those who are rich, their friends.”

Japan’s benchmark interest rates are among the world’s lowest and have been for decades.

A recent poll by the daily Mainichi paper showed 55 percent of respondents said the BOJ should review current monetary easing, far higher than 22 percent who favoured the status quo.

While Kuroda maintains ultra-low rates are still needed to support a fragile economic recovery, others in the BOJ are starting to drop hints of a possible tweak to YCC.

The BOJ’s pro-stimulus camp, which held sway for most of Kuroda’s time in office, is seen further losing influence when the governor and his dovish deputy Masazumi Wakatabe see their terms end early next year.

That leadership transition would give bureaucrats an opportunity to shift further away from their outgoing chief’s controversial policy.

The assassination of Shinzo Abe in July, who as prime minister appointed Kuroda BOJ governor in 2013 and remained an influential proponent of massive stimulus, also meant a key loss of political support for advocates of expansionist monetary policy.

At the same time, BOJ officials are now preparing the theoretical backbone for a future policy shift, releasing research on whether companies and households are finally shaking their entrenched aversion to price hikes.

“If inflation stays elevated, there is no reason to keep interest rates at current levels,” said one of the sources.

“The BOJ needs more evidence that wages will rise steadily. Once that’s available, the BOJ may see scope to act,” another source said, a view echoed by three more sources.

Treading carefully

During his decade in office, Kuroda, in his bid to fire up inflation to 2 percent, introduced massive asset-buying and YCC, a complicated programme that combined a negative short-term rate target and a 0 percent cap on the 10-year bond yield.

More recently, the BOJ has quietly unwound some of these measures, by slowing those asset purchases. The next step would be to revert to a policy solely targeting short-term rates, a process that could take years, the sources said.

With Japan’s huge debt pile making an abrupt rate hike too costly, the BOJ will tread cautiously and explain the shift as a gradual move toward a normalization of extraordinary stimulus – rather than a full-fledged monetary tightening, they said.

But policymakers also know they are running out of time to address the huge costs of the BOJ’s relentless defence of its 0 percent yield cap, such as diminishing bond market liquidity, crushed bank margins and a crippling yen sell-off.

“A policy tweak isn’t a done deal but if public anger over inflation heightens, the BOJ could feel compelled to act,” said Izuru Kato, chief economist at Totan Research in Tokyo.

Hawkish hints

Already, public discontent is putting the BOJ’s pro-stimulus camp on the backfoot. A reshuffle of the nine-member board in July brought in two newcomers, shifting the balance between the doves and hawks.

In a rare show of discomfort over current policy, former commercial banker and new BOJ board member Naoki Tamura told a recent interview the bank should conduct a review of its massive stimulus.

In his inaugural briefing, Hajime Takata, a former economist who replaced a vocal advocate of heavy money printing, said the BOJ must always think about an exit strategy.

While ruling out the need to ditch the yield cap now, Takata recently said he saw positive developments in wage growth.

The few remaining doves are hedging their bets.

“Trend inflation hasn’t reached 2 percent yet. But if there’s certainty that level will be met, it won’t be surprising for the BOJ to shift monetary policy,” Asahi Noguchi, who is known as a vocal advocate of aggressive easing, said earlier this month.

There is growing hope that long-stagnant wages will finally start to rise, a necessary condition for a policy change.

Japan’s umbrella labour union has decided to demand a 5-percent pay hike in next year’s spring wage negotiations, which, coupled with a tightening job market and repeated calls by government to raise wages, is pressuring firms to lift salaries.

While the BOJ won’t pull the trigger yet, it wants to be ready in case conditions for tweaking YCC fall into place, one source said.

In a shift away from its usual focus on economic risks, the board at its October policy meeting debated examining the side-effects of prolonged easing and the impact of a future exit from ultra-low rates, a summary of opinions at the meeting showed.

While dismissing the chance of a near-term tweak, Kuroda left room for a future shift by laying out a framework last month for when the BOJ exits ultra-loose policy.

BOJ staff are producing research on topics considered useful in guiding thinking on future monetary policy moves, just as they did before the shift to YCC in 2016.

One such note, published on Nov. 30, said prices were rising even among industries that once thrived on deflation such as drug stores, which used to offer big discounts.

Takeo Hoshi, a University of Tokyo academic who spoke at one of a series of BOJ workshops last month, said structural changes in Japan’s labor market could push up average wages more than they did previously.

“The BOJ must start worrying about the possibility of inflation accelerating more than expected,” he told Reuters, adding the BOJ may abandon its yield cap as early as next year.

Hoshi is among a group of academics who have regular interactions with BOJ policymakers.

UK lessons

With Kuroda’s days at the helm numbered, the task of an exit will be left to a new governor and his or her two deputies, who will be appointed by Prime Minister Fumio Kishida in April and March, respectively.

Unlike in 2013, when Abe hand-picked Kuroda to pull Japan out of deflation with a shock-and-awe approach, Kishida has little to gain by choosing a radical new governor.

The selection process is also complicated by Kishida’s precarious political standing, with his approval ratings rock-bottom after a wave of scandals forced three cabinet ministers to resign.

That means Kishida may instead choose a safe pair of hands to steer Japan cautiously towards an exit, say politicians and government officials close to the administration.

With their deep experience as career central bankers, deputy governor Masayoshi Amamiya and former deputy Hiroshi Nakaso remain top contenders to succeed Kuroda.

While vowing to keep rates low, Amamiya said in July the BOJ must “always” brainstorm ways to exit ultra-loose policy.

Nakaso also warned of the dangers of maintaining crisis-mode stimulus for too long, and laid out his version of an exit plan in a book published in May.

The path towards an exit, however, has plenty of caveats. A worse-than-expected U.S. recession or a huge slump in China’s growth could hit Japan’s economy, crushing the chance of a stimulus withdrawal.

Any step that increases Japan’s already huge debt-servicing cost could also face strong resistance by the government, which needs to fund a scheduled increase in defence spending.

Even if the BOJ were to move, communicating an exit plan would be challenging as just slight hints of a tweak to YCC could ignite a bond sell-off by scaring investors accustomed to the bank’s intervention, analysts say.

Such a reaction was seen in March when the BOJ was forced to pledge unlimited bond buying to defend its yield cap from speculative market attacks.

“The moment markets expect a policy tweak, the BOJ will find it hard to control the 10-year yield,” said Kazuo Momma, a former BOJ executive with experience drafting monetary policy.

“That’s why the BOJ won’t provide advance signals and remove the yield cap in a single step.”

Japan pays one-third of annual expenditures with debt issuance and spends over 20 trillion yen ($147.45 billion) each year to finance public debt that is twice the size of its economy, making even a small rise in long-term borrowing costs catastrophic.

Some policymakers see lessons for Japan from Britain’s market rout in September, when then premier Liz Truss’s plan for unfunded tax cuts triggered a bond sell-off that forced her to resign.

“Everyone understands the BOJ must eventually head for the exit,” said Yasushi Kinoshita, a former top finance ministry bureaucrat considered as a deputy BOJ governor candidate.

“There’s also consensus that the BOJ must move cautiously and steadily. If interest rate control doesn’t go well, there could be huge market turbulence.”

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