In the end, BOJ governor Haruhiko Kuroda tried his best to pull off a Mario Draghi – introducing a tightening event while smothering it in “easy” forward guidance – and failed.
While Kuroda was not faced with anything nearly as dramatic as announcing the end of QE as Draghi did last month, the BOJ head still tried having his monetary easing cake while somehow modestly steepening yield curves to give Japanese banks a little extra support now that the BOJ has been forced to admit that its inflation targeting timeframe has been a disaster, and QE will continue indefinitely, or at least until it runs out of bonds to buy. For now, it is unclear if he will succeed, especially since the market’s reaction was not what Kuroda had expected, and for good reason: the “market” knows well that even the smallest gambit to reverse policy would blow up in Kuroda’s face. But that doesn’t mean he won’t try.
As a reminder, here is what happened overnight: as previously leaked to the press, the BOJ took – or at least tried to take – several steps to alleviate the strain on banks and the market distortions stemming from its policy while keeping unchanged its two major benchmarks – negative interest rate and the 10-year yield target of 0%. The central bank added modest flexibility on rates while keeping the 10Y anchored at 10%, it also pulled a page out of the ECB’s playbook and added forward guidance on rates, while making small superficial changes to its ETF buying program.
The initial response was underwhelming, with JGB yields sliding after the announcement was released just minutes after 1pm local time, as the market realized that contrary to the leaks, the BOJ would keep its Yield Curve Control in its current form.
For those who missed our initial report, here are the key highlights from the most anticipated BOJ statement in 2 years:
- Negative interest rate of -0.1 percent maintained, but will apply to fewer reserves to cushion the impact on commercial banks
- Target yield for 10-year bonds remains 0%
- The BOJ added language stating that “the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices.”
- Just like the ECB, the BOJ added forward guidance to its policy rates, with a commitment to keep the current extremely low levels for short- and long-term interest rates for an “extended period of time”
- Overall purchases of exchange-traded funds are kept at 6 trillion yen ($54 billion) but those linked to the Topix will increase to 4.2 trillion yen, from 2.7 trillion yen, further reducing the weighting of the narrower Nikkei 225
Perhaps in an attempt to reverse the market’s initial disappointment, during the press conference that followed a few hours later, Kuroda indicated that the BOJ will tolerate 10-year yields deviating as much as 0.2% from zero, compared with 0.1% now as the decline in JGB trading meant market function has been declining. However, even here Kuroda was afraid to go too far, and said he doesn’t think there is a need to keep expanding the range.
In other words, instead of blowing out as far as 0.1%, the 10Y JGB may now hit as much as 0.2% before the central bank steps in with one of its fixed-rate operations.
Meanwhile, the main reason why Kuroda was unable to indicate tightening is that also today the BOJ sharply cut its inflation forecasts, suggesting it’s preparing for an even lengthier battle to generate 2% price gains, and further widening the gap with central bank peers who are moving away from crisis-era policies. The headline of the BOJ’s statement underscored the goal: “Strengthening the Framework for Continuous Powerful Monetary Easing.”
“The BOJ is now more engaged and prepared to fight a long-run battle against deflation or disinflation,” said Shigeto Nagai, Head of Japan Economics at Oxford Economics.
Meanwhile, “Putting forward guidance in the statement just merely acknowledges what the BOJ has been implementing, and it just means the bank will continue to carry on YCC without changing the framework” said Akio Kato, trader at Mitsubishi UFJ Kokusai Asset Management.
As a result, Japan’s 10-year JGB sank 4 points to 0.062%, the lowest in more than a week…
… while the Japanese yen decreased 0.4 percent to 111.50 per dollar, the weakest in more than a week.
The Topix stock index sank 0.8% to the lowest in a week on the biggest decrease in almost four weeks, dragged lower by banks as hopes of even a modest sustainable steepening in the yield curve proved false.
Perhaps the most important datapoint in the entire announcement was Kuroda’s implicit admission he has failed on the bank’s stated goal of hitting 2% inflation. The central bank now sees core consumer prices rising just 1.1% in the current fiscal year through March, down from 1.3% projected previously. The estimate for fiscal 2019 was cut to 1.5%, from 1.8%, while fiscal 2020 was trimmed to 1.6%, from 1.8%.
“Prices and wages are both rising, but the central bank’s previous forecast that 2 percent inflation would be reached in the 2019 fiscal year has been delayed” Kuroda said, and the BOJ head also admitted what we predicted all the way back in 2012, in why QQE would fail: “Inflation did rise to 1.5% a fast acceleration, but wages didn’t rise, stopping consumption” Kuroda said, and conceded that he “does’t have a calendar for reaching 2% inflation, but believe prices will gradually rise.”
Maybe. Just not in the near term, which is why for all the leaks of rumors tightening, the BOJ just extended its easy policy runway by another 2 years to give inflation one final chance to hit its target.
“They tried their best to avoid the perception of tapering or normalization by introducing the forward guidance,” said Nagai, confirming that the most recent topic of dinner conversation at the Basel Tower was how Kuroda can successfully imitate what Draghi pulled off recently.
“The guidance is vague but gives some assurance that the current easing measures will continue at least into fiscal 2020, after checking the side effects of the planned consumption tax hike.”
Which is great: nobody expected Kuroda to be able to hypnotize the market like Draghi; he does however have a far bigger problem – whether he wants to admit it or not, Draghi is tightening and tapering for one simple reason: the central bank is running out of bonds to buy. And when the downward sloping curve below hits 0, it’s game over.