BOJ Decision-Day Guide: Kuroda Faces Off With Frenzied Markets

(Bloomberg) -- The Bank of Japan concludes a two-day policy meeting on Tuesday amid intense speculation that it may adjust its massive monetary stimulus program. Economists who study the BOJ closely say such talk is premature.

Investors should brace for volatility in markets whatever the outcome. The central bank has been forced to conduct fixed-rate operations three times this month to curb rising yields on benchmark 10-year Japanese government bonds, the yen is primed to strengthen on any signs of tighter policy and some traders have placed bets on the possibility of changes to the BOJ’s stock purchases.

Governor Haruhiko Kuroda has stared down markets before, including in January when suggestions of normalizing policy emerged. All 44 economists surveyed by Bloomberg expect him to hold firm again on Tuesday given the weakness in inflation. If he does, the gulf will widen between the BOJ and its peers the U.S. Federal Reserve and the European Central Bank, which are winding back crisis-era settings.

Here are key points to watch when the policy meeting ends around noon in Tokyo, and at Kuroda’s briefing, which begins at 3:30 p.m.:

Inflation forecasts

The BOJ is likely to cut its forecasts for inflation in the quarterly outlook report that accompanies the monetary policy statement. Its 1.3 percent projection for core consumer prices in the current fiscal year appears overly optimistic given that the most recent reading was 0.8 percent. The estimates of 1.8 percent for each of the next two fiscal years also look to be a stretch.

With prices already far from the central bank’s 2 percent target, any downgrades will underscore the need to continue with aggressive stimulus. Paradoxically, critics of the BOJ argue that the longer the program continues, the greater the need to adjust it to curb side effects.

The BOJ has been examining the weakness in price gains in the lead-up to this meeting and any conclusions it draws will be scrutinized for hints to future policy adjustments. To date, Kuroda has maintained the view that price momentum is still in place.

Side effects

Any suggestion of greater concern about the decline in profitability of commercial banks, distortions in the bond and stock markets, or the overall sustainability of stimulus, may foreshadow policy tweaks are on the horizon.

The last time the BOJ shifted its policy framework was in September 2016, when it introduced the yield-curve-control program.

Bloomberg Economics’ Yuki Masujima said a blitz of news reports suggests that policy makers are examining how to reduce unintended harm from their program, but not immediately. "A move in July would clearly be too early, but it looks like the BOJ may be starting to lay the groundwork for a possible policy tweak toward year-end," he said.

Bond purchases

The BOJ has already managed a de facto taper of the quantity of JGBs it purchases, making a fiction of the guideline for increasing its holdings by about 80 trillion yen ($720 billion) per year. But its yield-curve control settings are being tested.

Reports suggest that the central bank could tweak YCC to allow for a more natural increase in long-term interest rates or make operational changes to the way it buys bonds. The risk here is that any change seen as a move toward policy normalization would push the yen higher, undermining reflation efforts while also hurting exporters and the stock market.

Any inference of hawkishness could also have a bearing on the 269.5 trillion yen ($2.4 trillion) of overseas bonds owned by Japanese funds and thus global yields. Higher domestic yields could see a part of this money return home, especially as currency-hedging costs for dollar investments remain high.

Economists surveyed by Bloomberg think that when the BOJ does adjust policy, the most likely move is to raise the 10-year yield target from zero percent, but that this probably won’t come until next year.

Purchases of corporate bonds are also drawing fire, with commercial lenders privately complaining to the central bank about its purchases of this debt at negative interest rates, according to people familiar with the matter. Some officials at the BOJ are skeptical about whether these purchases are doing much to spur inflation but they are concerned that a change may give the wrong signal to markets, the people said.

ETF buying

The BOJ’s purchases of exchange-traded funds are having an out-sized impact on stocks in the Nikkei 225 Stock Average, the nation’s old blue-chip gauge. The Nikkei newspaper reported last week that the BOJ might buy more funds tracking the broader Topix index. That would be bad news for the share prices of firms such as Fast Retailing Co., SoftBank Group Corp. and Fanuc Corp., which have the heaviest weightings in the Nikkei 225.

The central bank diverted some of its stock purchases away from the Nikkei 225 once before, and doing so again would not be difficult.

Policy Recap

Key elements of the BOJ’s yield-curve control policy:

  • Negative interest rate of minus 0.1 percent charged on some of the reserves financial institutions keep at the BOJ.
  • Yield target of about 0 percent for 10-year Japanese government bonds.
  • Increase JGB holdings by about 80 trillion yen a year.
  • Increase holdings of exchange-traded funds by 6 trillion yen a year and Japanese real-estate investment trusts by 90 billion yen annually.
  • Maintain amounts outstanding of commercial paper and corporate bonds of 2.2 trillion yen and 3.2 trillion yen, respectively.

©2018 Bloomberg L.P.