What's Fueling Speculation the BOJ Will Change Policy

(Bloomberg) -- Renewed talk that the Bank of Japan is poised to adjust monetary policy has jolted financial markets, pushing up government bond yields and the yen. Bonds moved so sharply that the central bank took the rare step on July 23 of offering to buy an unlimited amount of 10-year debt at a fixed rate to pull yields back in line. The turmoil underscores the BOJ’s seemingly impossible task of setting a sustainable monetary policy to generate inflation without unwelcome side effects.

1. Why the fresh speculation of BOJ policy changes?

Questions were bound to be raised about policy settings after yet another batch of weak inflation data, and with BOJ board members due to issue new price forecasts at their July 30-31 meeting. A flurry of news reports that began on July 20 provided the catalyst. They indicated debate inside the BOJ about what might be done to reduce harm to markets and commercial banks given that stimulus to spur inflation looks like it will be needed for a lot longer.

2. What specific policy changes might the BOJ make?

BOJ watchers and the recent news reports suggest a range of options. The strongest would be raising the yield target for 10-year bonds from zero or lifting the -0.1 rate on some bank reserves. Most economists who follow the central bank don’t see this happening until next year, and certainly not this month. Another possibility is removing the 80 trillion yen target for annual increases in bond holdings, which is already well below this guideline. News reports pointed to the possibility of a tweak to the yield-curve control to allow for a more natural increase in long-term interest rates, or of tolerating a wider trading range for 10-year yields. Other possibilities are operational changes to how the BOJ buys bonds and exchange-traded funds. Changes to the index weightings that determine ETF purchases have been made before and could happen again. The most minimal approach for July 31 could be no policy change from the BOJ but an assurance it’s examining how to minimize harm.

3. What has Kuroda said about normalizing policy?

Governor Haruhiko Kuroda said earlier this year that the BOJ may start thinking about how to exit its stimulus around the fiscal year starting next April. He walked back this comment soon after, emphasizing that he didn’t mean policy would change at that time -- only that the BOJ would be thinking about what to do then as inflation neared the 2 percent target. He’s also indicated that the central bank could begin adjusting its policy before hitting 2 percent, but without giving any details. But keep in mind that Kuroda has always insisted that the BOJ would continue stimulus until 2 percent is reached.

4. If inflation’s weak, shouldn’t the BOJ add stimulus?

Even though inflation remains far from the 2 percent target, more than 90 percent of economists surveyed by Bloomberg think the next move will be to tighten policy rather than loosen it. Many argue that the BOJ has reached the limits of monetary stimulus -- something the central bank tacitly acknowledged when it changed its policy framework to yield-curve control in 2016. Economists also say the program can’t go on forever, given that ultra-low interest rates undermine the profitability of commercial banks while bond markets no longer function properly because of the BOJ’s purchases. Thirty-nine percent of economists said they didn’t think the current settings can go on for more than another two years. The central bank’s balance sheet has swollen so much that it’s poised to soon surpass the size of the nation’s annual economic output.

5. Did the BOJ just fly a ‘trial balloon’?

Some people think so. Bloomberg Economics’ Yuki Masujima says the recent news reports suggest the BOJ is signaling markets that policy won’t be on autopilot forever. He predicts a rate hike as early as October. Masaaki Kanno, chief economist at Sony Financial Holdings, said the BOJ was sending a message that it intends to raise the 10-year yield target within a year. He said he now expects such a move in January.

6. What can we expect the BOJ to do on July 31?

Expect the central bank to lower its inflation forecasts. Don’t count on a change to policy. All 44 economists surveyed said the BOJ will maintain the current settings on interest rates and asset purchases. The BOJ is likely to offer some explanation of why inflation isn’t rising as fast as it had expected, and Kuroda is almost certain to reiterate his commitment to maintaining stimulus and reaching the 2 percent target. Yet look for any signal from the governor indicating a willingness to adjust policy as inflation rises toward the goal, rather than after it has been reached.

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