U.S. Economy Could Force BOJ's Hand on Rates, Kuroda Ally Says

(Bloomberg) -- The Bank of Japan’s next policy move may end up being raising its bond-yield target to keep the yen from weakening too much, according to a Kuroda associate and BOJ adviser.

While the yen has strengthened this year, Masahiro Kawai said in an interview on Monday that the central bank needs to be prepared for a possible overheating of the U.S. economy that could quickly weaken the Japanese currency.

“The BOJ would want to stop that before the yen gets too weak," said Kawai, a longtime associate of BOJ Governor Haruhiko Kuroda, adding that such a move wouldn’t indicate a policy exit. "The limit is maybe 125 per dollar -- 130 is obviously excessive.”

The U.S. Federal Reserve is expected to raise interest rates three or four times this year, while most analysts predict the BOJ will its leave its ultra-loose policy settings unchanged until next year. The rate divergence with Japan may widen further if corporate tax cuts and infrastructure spending cause the U.S. economy to overheat, raising the risk of excessive yen depreciation, Kawai said.

The BOJ has undertaken a combination of asset purchases, negative interest rates and yield curve control in an effort to achieve 2 percent inflation and reflate the economy. The BOJ’s current target for the yield on the 10-year Japanese government bond is around zero percent.

With its inflation target still far away, the BOJ must continue its current monetary stimulus for now, Kawai said. Inflation should pick up later this year, buoyed by a tightening labor market, and by next year the BOJ will start to have an idea of when they may be able to discuss an exit, he said.

While a weak yen helps the BOJ’s efforts to stoke inflation -- and has been an unspoken policy objective -- too much weakness can hurt businesses that import raw materials, while some consumers would feel the pain of higher prices for imports.

‘Kuroda Line’

Some traders call the zone around 125 yen to the dollar the “Kuroda line.” The governor’s comments in June 2015 caused the yen to appreciate after touching a 13-year low. The currency was trading at 109.95 versus the dollar as of 1:55 p.m. in Tokyo on Tuesday, having gained 2.5 percent this year.

Kawai said excessive weakness in the currency could also result in a sharp reversal in the opposite direction, while the BOJ wants to keep the exchange rate relatively stable. To adjust the yield target, communication with markets must be carried out very carefully, he said.

More: BOJ’s Kuroda Starts New Term With Fresh Commitment to Easing

Kawai, who worked with Kuroda at the Ministry of Finance in early 2000s, is one of 10 BOJ advisers. They don’t make specific policy proposals.

The BOJ holds its next policy meeting June 14-15.

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