The Bank of Japan’s ultra-accommodative monetary policy is one of the few vestiges of the 2008 global financial crisis. While other major central banks are beginning or continuing to normalize policy, the BoJ remains steadfast in its easing. This discrepancy between Japan and the rest of the world was on full display at its recent policy meeting, when Governor Haruhiko Kuroda bucked market expectations by keeping Japan’s 10-year government bond (JGB) yield target at zero.
Before the meeting, investors were betting heavily that the central bank would finally begin its de-facto tightening process by raising the JGB target rate – the 10-year JGB yield surged to 0.145 percent, an 18-month high, before the meeting. In fact, because of its role in keeping global rates lower, the BoJ’s decision to keep its monetary policy broadly the same led to a relief rally in global long term rates, which trended down in the days before the meeting.
Despite the disappointment, Kuroda’s policy statement mentioned that “yields may move upward and downward to some extent mainly depending on developments in economic activity and prices.” This means that the central bank is taking a more flexible approach on how it manages long-term JGB rates; Kuroda expressed his expectation for the 10-year yield trading band to double from +/–0.1 percent currently to +/–0.2 percent (see chart). So it is likely that the yield trades above 0.1 percent.
The reason cited for keeping yields the same was Japan’s inflation outlook. The BoJ trimmed its CPI forecasts to 1.1 percent from 1.3 percent for FY2018, to 1.5 percent from 1.8 percent for FY2019, and to 1.6percent from 1.8 percent for FY2020. Now that it’s clear that its 2 percent inflation target cannot be achieved even in 2020, the BoJ emphasized that its policy adjustments (discussed below) were meant to make its policy more sustainable, and that it was not the beginning of a policy exit.
It seems likely that it will take longer than we previously expected for the BoJ to raise its 10-year JGB yield target. In its policy statement, the BoJ said it “intends to maintain current extremely low levels of short-and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices, including the effects of the consumption-tax hike scheduled to take place in October 2019.”
Although we still believe the BoJ will raise its 10-year JGB yield target over the medium term, it may allow further increases in the actual 10-year yield even within its “around zero” target when it becomes clear that Japanese inflation is accelerating. We expect core CPI to be above 1 percent by the end of FY2018, supported by solid domestic demand and an acute labor shortage.
In addition to standing pat on rates, the central bank made several dovish adjustments. First, while maintaining the pace of its net JGB purchases at 80 trillion yen a year, the BoJ added that it “will conduct purchases in a flexible manner.” Its purchases of exchange-traded funds (ETFs) and Japanese real estate investment trusts will get the same treatment. We think the BoJ will de-emphasize the quantity of asset purchases even as it braces itself for a prolonged period of monetary easing.
Second, the BoJ revised its allocation for its ETF purchases, increasing the amount for TOPIX-linked ETFs and decreasing that for Nikkei-linked ETFs. This decision should benefit banks and transportation-equipment companies, but may hurt retailers, electric appliance makers and telecommunications companies.
Third, while the BoJ maintained its short term policy rate – the rate applied to parts of its excess reserves – it halved the amount subject to this negative interest rate, to 5 trillion yen from 10 trillion yen. This move may be interpreted as a slight monetary tightening, but its impact on short-term yields should be limited.
Considering these policy announcements, we keep our USDJPY forecast range at 107–112 for the next six months. While introducing forward guidance will prevent rapid yen appreciation due to markets’ speculation about the BoJ’s early exit policy, allowing further moderate rate increases around the zero percent target will likely weigh on USDJPY.
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