BOJ takes steps to make policy flexible but vows to keep rates low

Tokyo: The Bank of Japan took measures to make its massive stimulus programme more flexible and pledged to keep interest rates low for the time being on Tuesday, reflecting its forecast that it would take time for inflation to hit its 2 per cent target.

The decision underscored the challenges the BOJ faces as stubbornly weak inflation forces it to maintain a massive stimulus programme despite the rising costs of prolonged easing.

The changes indicate that while Governor Haruhiko Kuroda plans on keeping radical stimulus programme in place for now, he is looking at the impact the policies are having on other parts of the economy, such as the financial markets and banking system.

Ahead of the policy announcement, market speculation had grown that the central bank might raise the prospect of an interest rate rise - the absence of any such action or guidance on Tuesday drove a decline in bond yields and helped stocks claw back earlier losses.

“It is a very mild policy change by the BOJ but its policy vector is heading towards tightening. The BOJ’s message was to let long-term yields go higher,” said Hiroaki Mutou, chief economist at Tokai Tokyo Research Institute.

“I think the BOJ was successful in tweaking its policy scheme which did not greatly impact markets but introduced a tool, forward guidance for policy rates, for future tightening.”

At a two-day rate review that ended on Tuesday, the BOJ decided to maintain its short-term interest rate target at minus 0.1 per cent and a pledge to guide 10-year government bond yields around zero per cent by a 7-2 vote.

But the central bank said it would allow long-term rates to fluctuate depending on economic and price developments, and conduct its asset purchases more flexibly.

“Yields may move upward and downward to some extent mainly depending on economic and price developments,” even as the BOJ guides them around zero, the central bank said in a statement announcing the policy decision.

The bank also said it will conduct bond purchases in a “flexible manner” in meeting a loose pledge to increase its bond holdings by around 80 trillion yen ($720.27 billion) per year.

Japanese shares pared losses while the yen fell and yields on Japanese and US bonds declined on Tuesday after the BOJ decision, which stayed away from making drastic changes to its accommodative policy.

The Nikkei turned positive while the dollar gained 0.25 per cent against the yen to 111.33 yen.

In an apparent move to keep yields from rising too much on expectations of future policy normalisation, the BOJ adopted forward guidance on policy rates that pledges to keep rates low for the time being.

“The BOJ intends to maintain current extremely low levels of short- and long-term rates for an extended period of time,” taking into account uncertainties over the outlook including the effect on the economy of next year’s scheduled sales tax hike, the bank said in the statement.

The BOJ also said it will make tweaks to the way it buys risky assets, such as raising the composition of Topix-indexed exchange traded funds (ETF) to ease distortions created by the central bank’s purchases.

“There was no major policy scheme change but the main part of the policy announcement was the BOJ’s response to a decline in market function,” said Izuru Kato, chief economist at Totan Research.

“We can say it is a step towards normalisation of monetary policy but it was a fine adjustment and the BOJ is expected to keep the existing policy framework.”

Inflation falling short

In a quarterly review of its projections also released on Tuesday, the BOJ trimmed its price forecasts and conceded inflation could fall short of its target for three more years.

The central bank has failed to break Japan’s entrenched deflationary mindset despite years of heavy money printing, with stubbornly soft inflation sapping its ammunition and global trade woes clouding the outlook for an export-reliant economy.

But there is uncertainty over how long it can sustain the current ultra-easy policy given the strain near-zero rates are inflicting on Japanese banks and the bond market.

Aside from its yield targets, the BOJ floods markets with cash by buying risky assets such as ETFs and corporate bonds. It also keeps a loose pledge to increase its government bond holdings by 80 trillion yen ($720.79 billion) per year.

The BOJ’s asset purchases have been criticised for drying up market liquidity and distorting market functions. Faced with calls its bond buying is nearing a limit, the central bank has steadily slowed purchases to roughly half the level it loosely pledged to take up.

The BOJ meeting precedes the US Federal Reserve’s two-day rate review through Wednesday, which is expected to reaffirm the outlook for further gradual rate rises.