BOJ yields some control, but also throws a curve

Governor of the Bank of Japan Kazuo Ueda. (Source: Bloomberg)

The Bank of Japan has taken a small step toward relinquishing its longstanding attachment to ultra-loose money. But don't expect the central bank to proceed briskly along the path of anything resembling normal interest rates. Such a move is way off, if it ever happens. Unlike many of its peers, the BOJ still wants to kindle inflation. On Friday, it acknowledged some progress — and stepped on its message.

That is the key to understanding the half-hearted nature of what transpired. In allowing long-term rates to rise somewhat beyond its comfort zone, the BOJ surprised a majority of economists, who predicted that the previous ceiling on 10-year bond yields of 0.5 percent would be retained. However, Governor Kazuo Ueda refrained from specifically lifting the limit to 0.75 percent, as a minority had predicted, or abandoning it entirely.

The result is an unedifying fudge that formally keeps the threshold at 0.5 percent, while simultaneously relegating that marker to a reference point and not a “rigid” limit.  To further downgrade the threshold — without bringing itself to entirely abandon the ground — the BOJ said it will offer to purchase unlimited amounts of 10-year government bonds daily at a rate of 1 percent. Effectively, that makes 1 percent the new roof. So why not just come out and say that? For a guy who wanted to put the shocks
and verbal theatrics of his predecessor, Haruhiko Kuroda, behind him, Ueda could use some weekend detention at the school of monetary communications.

Part of the drama that gripped markets Friday is the sequence of events. In recent comments, Ueda had appeared to play down the need for a shift and, while investors anticipated at least some dismantling of yield-curve control later this year, there was little sense any change was imminent. When Nikkei reported during New York hours that the BOJ would discuss tweaks, ripples were felt across global markets. The yen jumped, as did rates on everything from US Treasuries to Australian sovereign debt. The yen and Japanese yields whipsawed after the announcement, given the something-for-everyone quality of the statement. Both then headed higher.

There's a powerful camp that says “I told you so.” Even before Kuroda jolted investors in December by suddenly doubling the yield cap to 0.5 percent, there was a degree of skepticism about official noises suggesting no need for change. This group held that the best time for Ueda to move would be precisely when there was little expectation of action. In that sense, yield-curve control is like an exchange rate. You don't advertise revolutions in currency rules in advance. The speculators you are trying to defeat will get the better of you.

In fact, the vagueness of the BOJ's new language may only encourage bets on the demise of YCC and ultimately, negative interest rates. After all, Japan is no longer threatened by deflation and the economy is no longer in the precarious state that existed in 2016 when yields were pegged and the key rate pushed south. (If any big economy is threatened by deflation, it's China.)

But the BOJ's goal has been to not only get inflation to 2 percent, but ensure it can settle stably above that target. While consumer prices are rising, Ueda is loath to even whisper “mission accomplished.” He was a member of the central bank panel that voted, disastrously, for a rate hike in August 2000 just as the global economy was slowing. The hike had to be undone the following year and then-Governor Masaru Hayami never recovered his credibility. Happily for Ueda, he cast a dissenting vote on that occasion.

This time, he may have been too clever by half. Ueda has moved things in the direction of less easy money, but at what cost? “The move tarnishes Governor Kazuo Ueda’s reputation as a clear communicator,” wrote Taro Kimura of Bloomberg Economics. “Ueda has been consistent in sending dovish signals. But his actions may now be perceived as unpredictable and even hawkish.”

For a man who is credited with inventing the very concept of forward guidance, this is an unexpected misstep. Kuroda developed a reputation for surprises, but his were generally designed to shock the market into action. Friday’s rug-pull and contradictory statements — the BOJ still says its target for long-term rates is “around zero percent,” which no longer makes sense in a world where it will cap rates at 1 percent — risk muddying the waters even further. Given that the statement makes reference to three different targets for the 10-year yield, it’s easy to see why some were confused.

Ueda may be trying to keep several plates spinning. The reason for his caution is understandable, as the statement laid out: “The price stability target of 2 percent, accompanied by wage increases, has not yet come in sight.” (Italics are ours.) Ueda has explicitly expanded the bank’s target to not just rising prices, but gains from higher wages. Japan’s annual wage negotiations, however, mean it takes time for changes to filter through the economy. Encouragingly, the BOJ said that “signs of change have been seen in firms' wage- and price-setting behavior,” suggesting that at a future point — certainly after next spring’s talks, if not later — the BOJ might start to wonder where the exit is.

Ueda defended the move as a technical change designed to make YCC more sustainable, and give the bank ammunition in case prices overshoot its target. “I don't see rates rising to 1 percent but we have the cap just at 1 percent just in case,” Ueda said. “This is not a step towards policy normalisation.” He also noted it was a good time to make such a change. And he might be right; talk of a snap election has dried up, offering the bank a window that didn't originally exist.

Nonetheless, the bank is sticking to its view that it still expects inflation to fall slightly below its target next year. For all the caution over “transitory” price increases, there are good reasons to believe it won’t be caught on the wrong side of that bet — producer price inflation posted its lowest year-on-year growth since May 2021, while service inflation is at the lowest since 2020. The last thing the BOJ wants to do is anything that would choke off price gains, just when it seems it might finally reach its goal.

In a week that saw the Federal Reserve and the European Central Bank signal the most aggressive hiking campaign in decades is near an end, Japan has taken two steps forward and one step back. The country is moving away from a complicated framework that was designed to make mega-easing sustainable. Officials can’t bring themselves to say that, and in the process are just making things more complex. So-called unconventional policy is much easier to embark upon than dismantle. Especially if you feel you must do so by stealth.

Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Gearoid Reidy is a Bloomberg Opinion columnist covering Japan and the Koreas. Views are personal and do not represent the stand of this publication.

Credit: Bloomberg