Policy-making at the Bank of Japan just got a whole lot more flexible.
Gone are the days of rigid annual targets. It’s now all about having the ability to adjust interest rates and asset purchases based on the evolving outlook for inflation.
That’s the initial take from the bank’s September monetary policy statement with risk assets rallying across Asia as investors welcome the latest in a long line of attempts to stir inflationary pressures.
Instead of targeting an annual increase in the nation’s monetary base of around 80 trillion yen, the bank will now target the shape of the Japanese yield curve, announcing that it will purchase Japanese government bonds (JGBs) with the aim of keeping the 10-year JGB rate “more or less at the current level” of around 0%.
“With a view to achieving the the price stability target of 2 percent at the earliest possible time, the Bank decided to introduce ‘QQE with yield curve control’,” the bank stated.
“With regard to to the amount of JGBs to be purchased, the bank will conduct purchases more or less in line with the current pace — an annual pace of increase in the amount of outstanding of its JGB holdings at about 80 trillion yen.”
So while the scale of asset purchases is expected to be roughly the same as it was previously, the bank is now targeting interest rate levels, not just the amount of assets that it purchases.
“The new yield curve control policy means, by definition, that the JGB asset purchase program can no longer be a hard target,” said Robert Rennie, FX strategist at Westpac. “Some months they will buy a lot, some months they will not.”
In order to target the shape of the yield curve, the bank will now target JGBs “with a wide range of maturities”, scrapping the previous stance of purchasing securities with a set time frame to maturity of between 7 to 12 years.
This will allow for greater flexibility in terms of policy settings, allowing the BOJ to make necessary adjustments based on the inflation outlook.
The bank left its annual purchases of exchange-traded funds and Japan real estate investment trusts unchanged at about 6 trillion yen and 90 billion yen respectively.
Outside of asset purchases, the bank decided to leave its key interest rate unchanged at -0.1%, surprising many analysts who had expected that rates would be taken even deeper into negative territory.
Of the 21 economists polled by Reuters who were forecasting an increase in BOJ stimulus, two-thirds believed it would be provided by a rate cut.
While it refrained on this occasion, the BOJ stated that its official interest rate can still be reduced, if required.
“With regard to possible options for additional easing, the bank can cut the short-term policy interest rate and the target level of long-term interest rates, which are two key benchmark rates for yield curve control,” it stated.
The bank also announced a “inflation-overshooting commitment”, essentially a pledge to expand the nation’s monetary base until the annual increase in consumer price inflation (CPI) exceeds its price stability target of 2% “and stays above the target in a stable manner”.
“This is to refute concerns the BOJ might start reversing its QQE policy anytime soon and in the hope this will strengthen inflation expectations”, said Ray Attrill, global co-head of FX strategy at the National Australia Bank. “To this end it has expressed a willingness to allow inflation to overshoot the 2% target – however implausible that appears in practice.”
The pledge to overshoot on inflation, coupled with greater policy flexibility now available to the bank to achieve that goal, has, for the moment, been welcomed by financial markets.
The Japanese yen has weakened with the USD/JPY currently trading at 102.58, up 0.88% for the session. The Nikkei is also rallying, sitting up 1.23% as at 2pm in Tokyo.
Bond yields, now central to BOJ monetary policy moving forward, have also lifted. The 10-year JGB yield currently sits at -0.022%, having traded at -0.049% just moments before the decision was released. It briefly rose to zero percent, a level that had not been seen since the middle of March this year.
While he remains sceptical as to whether it will work, Attrill suggests the policy shift from the BOJ is not only about helping to boost inflation but also an attempt to unwind some of the pressure on Japan’s financial and corporate sector as a result of past policy decisions.
“To the extent that the initial move to negative rates in January and subsequent curve flattening crushed banking stocks, the broader stock market and induced risk-negative yen strengthening, today’s moves can be viewed as an attempt to partially unwind the cause/effects of those actions,” he said following the announcement.