On December 20, the Bank of Japan (BOJ) raised its ceiling on 10-year government bond yields from 0.25 percent to 0.5 percent. Within minutes of the announcement, the yen appreciated against the US dollar by 3 percent, the Nikkei 225 fell by 2.5 percent and the 10-year bond rate jumped about 25 basis points to approach the new ceiling.
This sharp reaction was because the decision took investors by surprise. The BOJ has long been intervening in the bond market to keep yields anchored close to the zero-bound, and the market was expecting it to maintain its “yield curve control” (YCC) policy until the end of BOJ Governor Haruhiko Kuroda’s 10-year tenure in early April.
However, allowing more flexibility in the 10-year bond market has become necessary to reinforce the YCC’s effectiveness, Kuroda said.
The BOJ had been purchasing increasingly large sums of 10-year bonds at the 0.25 percent level, often adding them to its balance sheet a day after the Japanese Ministry of Finance issued them.
However, the BOJ was alarmed to find itself purchasing bonds at an accelerating rate. After all, the yield curve dipped at the 10-year mark, meaning the 10-year bond rate was lower than the nine-year and 15-year rates.
Although the YCC change is tantamount to a long-term interest-rate hike, Kuroda said that it should not be interpreted as the first step in a broader process of monetary policy tightening.
The real interest rate has been declining this year as the inflation rate has risen, he said.
By raising the cap on 10-year yields, the BOJ is effectively adjusting for inflation, not actually hiking the real interest rate. Kuroda is correct on this point.
However, the tweak to the YCC could be the first step toward monetary policy normalization.
If so, it should be heralded as a sign that the BOJ has had some success with its decade-long ultra-easy monetary policy. Kuroda’s Bazooka, as it is colloquially known, might have hit its mark.
Since Kuroda’s appointment in 2013, the Japanese inflation rate mainly hovered above zero, but far below 2 percent, leading some critics to argue that the BOJ’s inflation-targeting framework was a failure.
However, others defended the framework. From the perspective of a flexible inflation-targeting regime, the BOJ was balancing below-target inflation with Japan’s strong GDP growth — or the unemployment rate — in its evaluation.
One point was always clear: The BOJ had failed to anchor inflation expectations at 2 percent, which was supposed to be one of the great benefits of the inflation-targeting framework.
The inflation rate — excluding fresh food — has risen sharply. In January last year, it was still at only 0.2 percent. It had reached 2.1 percent by April and 3 percent by September. As in many other countries, this spike was driven by global energy and food price increases and a weakening currency.
As Japanese inflation has been far below that of the US (7.11 percent), the UK (10.7 percent) and the eurozone (10.1 percent), the BOJ — until last month — has consistently refused to raise interest rates.
As recently as October last year, the members of the BOJ Policy Board said that inflation would fall back to 1.6 percent this year.
However, there is reason to suspect that this forecast could be proven wrong. First, data for November last year show that the inflation rate, excluding energy and food prices, is at 2.8 percent. Even if energy and food prices stop rising this year, the inflation rate could remain above 2 percent.
Second, this year’s “spring offensive” — annual pay negotiations — is expected to bring large wage hikes, partly to compensate for the higher inflation rate last year, and partly to redistribute the higher profits stemming from yen depreciation.
Substantial wage increases would replace some of the “cost push” inflation of last year with “demand pull” inflation — by increasing many households’ relative spending power — which tends to be easier for consumers to accept.
That would be an ideal initial condition for the BOJ to start hitting its inflation target on a more sustainable basis. The new year might yet bring a happy ending to Japan’s decade-old ultra-easy monetary policy.
Takatoshi Ito, a former Japanese deputy vice minister of finance, is a professor at the School of International and Public Affairs at Columbia University and a senior professor at the National Graduate Institute for Policy Studies in Tokyo.
Copyright: Project Syndicate
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