The Bank of Japan: Counting on Kuroda

Earlier today saw the final Bank of Japan Policy Board meeting chaired by Governor Shirakawa. As expected, no changes were made to policy, a suitably inconsequential end to a term that saw GDP growth and inflation both average less than zero. Admittedly, with the economy returning to growth in the first quarter, and the recovery set to gain traction on the back of public works spending and the weaker yen, the near-term outlook looks more promising than when Shirakawa took office in April 2008. But – as implied by the BoJ’s own projections – current policy remains inadequate for the 2% inflation target to be met on a sustained basis over the foreseeable future.

So, when Governor-in-waiting Haruhiko Kuroda takes the helm later this month, he is expected to ring the changes at the BoJ. Quite what Kuroda and the new Deputy Governors – likely to be Abe’s nominees, Kikuo Iwata and Hiroshi Nakaso – will instigate, however, remains unclear. But several clues were provided in their testimonies to the Diet earlier this week, while recent discussions among the current Policy Board members suggest possible future shifts too. And with Kuroda no doubt eyeing recent policy changes at the world’s other major central banks too, we expect him to push for the following:

More asset purchases - Under current plans, the BoJ will increase its Asset Purchase Programme (APP) by ¥36trn in 2013. And at the start of 2014 it is set to shift to an ‘open-ended purchasing method’ under which the stock of securities held under the APP will increase by a further ¥10trn next year to ¥86trn, about 17% of GDP. Kuroda hinted this week that there might be merits in bringing forward immediately the start of the BoJ’s ‘open-ended’ purchases, implying that an extra ¥10trn of public and private sector securities will be bought this year. And with that move proposed at today’s meeting by one Policy Board member (Shirai), we see a significant chance of it being announced at Kuroda’s first meeting in charge in April.

APP purchases of longer-term JGBs - Despite maintaining purchases of longer-dated JGBs under its ‘rinban’ operations, the BoJ’s JGB holdings still account for little more than one tenth of the market, less than the Fed’s share of the UST market and less than half the Bank of England’s share of the Gilt market. So, the BoJ could commit to buy more JGBs without worrying about being accused of monetising the debt stock. Indeed, by limiting the JGBs purchased under the APP to those with a residual maturity of up to three years, the BoJ has eschewed a channel, used by other major central banks, for boosting demand and inflation. Recent meetings saw a few Board members consider an increase in the maturity of its APP JGB purchases to up to five years. Kuroda and Iwata suggested that the BoJ should buy JGBs with remaining maturities of more than five years. And Shirai also proposed this week to consolidate the APP and ‘rinbans’, which would seemingly have the same result. An increase in the maturity of the JGBs the BoJ purchases under the APP therefore looks inevitable.

Enhanced communication - A key element of current Fed policy – supporting positive inflation expectations and negative real interest rates – has been its commitment to maintain very low levels of the fed funds rate until the unemployment rate falls below 6 ½%. Japanese inflation expectations, on the other hand, remain below target while real interest rates are positive, acting as a significant constraint on demand and inflation. Given the importance of expectations in determining future inflation, as well as the defeatist approach to policy under Shirakawa – who repeatedly made clear that he did not expect the inflation target to be met – Kuroda needs to enhance significantly the BoJ’s communication strategy. So, as proposed in recent meetings by Board member Miyao, the BoJ could well take a leaf out of the Fed’s book and pledge at least to maintain its super-low interest rates (and possibly open-ended asset purchases) until certain key economic conditions are met.

So, next month, we expect the BoJ to announce a further increase in its purchases of securities, including longer-term JGBs, to be conducted this year, and move towards a more effective communication strategy that attempts to shift more significantly the inflation expectations of investors, firms and households. Of course, as ever, the devil will be in the detail of the new commitments. But with Japan’s equity markets at multi-year highs and JGB yields across the curve at multi-year (and, at some maturities, record) lows, the markets are certainly counting on Kuroda to implement more than mere incremental changes to the current policy setting. And if Japan’s economic performance under his stewardship of the BoJ is to be a marked improvement on that of his predecessors, let’s hope they’re right.


Chris Scicluna, Head of Economic Research

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