A new twist in the saga of Japan’s unconventional monetary policy

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Following its policy meeting on 21 September 2016 the Bank of Japan (BoJ) yesterday announced the following measures:

  • The BoJ maintains the rate for deposits held by financial institutions at the BoJ unchanged at – 0.10%.
  • A scrapping of the the 7-12 year average maturity target for bond buying in favour of a yield target on 10-year Japanese government bonds (JGBs) around the current level of 0%
  • A pledge to continue buying assets until inflation exceeds 2% and stays above the target in a stable manner.
  • New tools will be employed by the BoJ to faciliate control of the yield curve, namely: (i) outright purchases of JGBs at yields designated by the BoJ (fixed rate purchase operations); (ii) fixed-rate funds-supplying operations for a period of up to 10 years (extending the longest maturity of the operation from 1 year at present).

Here are my thoughts on each of these measures:

  • Although the short end of the JGB yield curve had discounted a good chance of a rate cut, the BoJ did not cut its deposit rate from the current level of minus 0.10 %. In their statement the BoJ said they would be prepared to cut the rate if they considered it necessary. In my opinion, a further reduction in the key interest rate would only be justified by an excessive appreciation of the yen versus the US dollar.
  • The BOJ introduced a new framework to strengthen their monetary easing called « Quantitative and Qualitative Monetary Easing with Yield Curve Control » (QQE with YCC). This new policy requires the BoJ to purchase whatever volume of Japanese government bonds (JGBs) is necessary in order that « 10-year JGB yields remain more or less at the current level (around zero %) ». Future volumes of JGB purchases will be conducted « more or less » in line with the exisiting objective of 80 trillion JPY/year. It is clear that this measure means the BoJ is shifting from a focus on balance sheet expansion to yield targeting. Further expansion of the BoJ’s balance sheet would be at the risk of encountering asset shortages (the BoJ already owns around 40% of the outstanding stock of JGBs) and thus potentially impede an efficient functioning of Japan’s financial system. So this is, to a certain extent, an acknowledgement that there are practical limits to the implementation of quantitative easing. In which case, its hard to avoid the conclusion that the BoJ is running short on ammunition to achieve its 2% inflation goal.
  • The new tools the BoJ has presented to facilitate control of the yield curve will enable it to prevent any excessive rise in the market yield, although I see very little risk of this eventuality in the next 12 months. The extension of fixed-rate funds-supplying operations from 1 year to 10 years is an aggressive extension of the funding period. However, as the BoJ is not currently conducting negative rate funding, I expect it to have little impact.
  • Under the new QQE with YCC policy, the guideline for average remaining maturity of the Bank’s JGB purchases will be abolished. This alone does not indicate in which direction the BoJ is heading. However, in conjunction with their zero % target for 10-year bond yields I would expect that the average remaining maturity target be shortened from the current 7-12 years to engineer a steepening of the yield curve. We will be able to obtain confirmation of this from the BoJ’s future JGB purchase operations. A steeper yield curve comes of course to the aid of Japan’s pension funds, banks and insurers (again highlighting the constraints to a policy of negative interest rates).
  • To bolster credibility in its target of 2% for annual inflation, the BoJ strenghtened its forward guidance by announcing an ‘overshooting-commitment’ of expanding its monetary base until CPI inflation exceeds 2%. The fact that all the BoJ’s huffing and puffing to raise inflation in Japan since 2012 has had no effect detracts considerably from the credibility of this ostensibly radical measure.

Overall, the market seemed underwhelmed by the BoJ’s package of measures – after weakening initially, the yen appreciated by 1% on the day versus the US dollar. The Japanese yield curve flattened as positions anticipating a rate cut were closed. The BoJ’s implementation of the new measures will have a major bearing on how the yield curve will evolve in coming months, but I would anticipate a continuation of the recent trend towards a steeper curve. Finally, I see nothing in this package that will slow the outflows of liquidities from Japan in search of yield in overseas bond markets.

Bank of Japan Governor Haruhiko Kuroda‘s term ends in April 2018. It may well be that he is now a lame duck, lacking credibility with financial markets. Unless slower global growth or some other exogenous factor leads to an excessive appreciation of the yen, Kuroda is unlikely to cut the deposit rate further, even if the rate of inflation hovers around 0%. Political opposition to negative rates  remains strong in Japan and technical limits are now apparent.

In a situation where global turmoil triggered a beggar-thy-neighbour round of currency devaluations, the BoJ could conceivably be forced to lower its short term and long-term yield targets. In this case and in order to spare the Japanese financial system from the consequences of negative rates, the Japanese goverment might accept negative interest rates for retail deposits in conjunction with fiscal easing and ‘helicopter money policies’.

Exhibit 1: The policy measures announced by the BoJ on 21/09/16 are the latest development of an unconventional monetary policy that began in 1999

Japan's unconventional monetary policy

Source: Bloomberg, as of 22/09/2016

Keeping track of the acronyms

The different phases of Japan’s unconventional monetary policy, as highlighted in Exhibit 1, are as follows:

  • The BoJ embarked on a Zero Interest Rate Policy (ZIRP) in 1999
  • QE1- In March 2001, the BoJ adopted a programme of quantitative easing that was to last four years. Under this policy, the BoJ used purchases of JGBs as the main instrument to reach their operating target of current account balances (CAB) held by financial institutions at the BoJ (bank reserves).
  • After signs that Japan’s economy was emerging from deflation the BoJ exited quantitive easing in March 2006.
  • Following the global financial crisis, the BoJ increased the pace of its JGB purchases and adopted a number of unconventional measures to promote financial stability. In October 2010 the BoJ introduced its comprehensive monetary easing (CME) policy to respond to the re-emergence of deflation and a slowing recovery. One key measure was an asset purchase programme involving government securities as well as private assets. This programme gradually morphed into the more aggressive intervention (QE3) that began in April 2013.
  • On 4 April 2013, in his first meeting as BoJ Governor Haruhiko Kuroda announced the introduction of quantitative and qualitative monetary easing (QQE) which committed the BoJ to open-ended asset buying with an objective of doubling the monetary base to 270 trn yen by the end of 2014. The BOJ commited to buying 7.5 trn. yen of long-term government bonds per month via two bond-buying schemes, its asset-buying and lending program and the “rinban” market operation, to buy longer-dated government bonds, including those with duration of 40 years. BoJ also announced an increase in purchases of exchange-traded funds (ETFs) by 1 trillion yen per year and real-estate trust funds (REITs) by 30 billion yen per year.
  • Expansion of QQE – on 31 October 2014 the BoJ announced it had decided to accelerate the pace of increase in the monetary base from 60-70 trillion yen to 80 trillion yen. In addition the BoJ announced a tripling of its purchases of exchange traded funds and Japan Real Estate Investment Trusts (J-REITs)
  • On 29 January 2016 the BoJ decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” whereby a negative interest rate (minus 0.10%) was applied to current accounts held by financial institutions at the central bank.
  • 21 September 2016 – the BoJ announces the introduction of Quantitative and Qualitative easing with Yield Curve Control [divider] [/divider]

This article was written by Naruki Nakamura on 22 September 2016 in Tokyo

Naruki Nakamura

Head of Fixed Income Japan

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