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Categorized | Currencies

Five key questions ahead of BoJ meeting

Posted on September 20, 2016

Bank of Japan governor Haruhiko Kuroda's 2013 pledge to hit 2% inflation has dented the bank's credibility©Reuters

Bank of Japan governor Haruhiko Kuroda’s 2013 pledge to hit 2% inflation has dented the bank’s credibility

The future of Haruhiko Kuroda’s programme of monetary easing will be on the line on Wednesday as the Bank of Japan governor publishes a “comprehensive assessment” of his aggressive monetary easing. The stimulus will continue — Mr Kuroda has made that clear — but here are some of the big questions the BoJ has to answer.

1. Will the BoJ ditch its timeframe for reaching 2 per cent inflation?

When Mr Kuroda started his easing programme in April 2013 he promised to hit 2 per cent inflation in “about two years”, a pledge that has caused trouble ever since. The target date has been pushed back again and again at high cost to the BoJ’s credibility. Today, Japanese prices are 0.4 per cent lower than a year ago.

Recently, Mr Kuroda has taken to saying he will hit the target “at the earliest possible time”, and the BoJ may make that official. Doing so should be good for its credibility — no other central bank pledges to hit a precise inflation number at a precise date — but the risk is that markets perceive it as giving up on 2 per cent inflation.

2. Do the benefits of negative interest rates outweigh the costs?

This is likely to be the most important part of the BoJ’s assessment. In a recent speech, Mr Kuroda for the first time acknowledged the costs of January’s move to negative interest rates. “For Japan in particular, the impact of the negative interest rate policy on the profits of financial institutions tends to be relatively large,” he said.

But he also hinted that the benefits outweigh the costs. If the BoJ states this clearly then markets will price-in deeper negative interest rates, even if Mr Kuroda does not cut them straightaway. That will be the BoJ’s strongest signal that it still has room to ease monetary policy further.

3. What will the BoJ say about its ¥80tn a year of asset purchases?

This decision comes in two parts. First, there has been market speculation that the BoJ could move to a range for asset purchases, such as ¥70tn-¥90tn a year, or even switch to targeting bond yields instead by setting caps at different points along the yield curve. Such a change is relatively unlikely for now, but the BoJ’s review might discuss options for the future, as its balance sheet gets ever bigger.

The second part is the average remaining maturity of the government bonds it buys, currently set at 7-12 years. One option is to shorten that, buying bonds with fewer years left to mature, in an effort to steepen the yield curve by raising longer-term bond yields. That would make life easier for banks, offsetting the cost of negative rates. Markets have already priced in a big yield curve steepening.

4. Will the BoJ actually change policy?

Quite separate from the big policy review is the question of whether to ease policy at this meeting. About half the analysts following the BoJ expect easing. They disagree wildly about how, but a rate cut to minus 0.2 per cent or minus 0.3 per cent is one option. Calendar-based forward guidance, pledging to keep rates low until a certain date, is another.

But there are several reasons for the BoJ to stay its hand. Economic data point to modest, stable growth with a fiscal stimulus from prime minister Shinzo Abe on its way. The BoJ already moved at its last meeting in July, upping purchases of equity funds.

    Most important of all, if the US Federal Reserve declines to raise rates later in the day, then any weakness in the yen due to the BoJ could be immediately offset. The BoJ does not want to appear ineffective, giving it reason to wait.

    5. How will the yen react?

    Expectations of a “game changer” are fading, say Tokyo forex traders. The consensus call is a mild rise in the yen against the dollar and continued testing of the ¥100 line during the final quarter of the year.

    Trading has stayed in a tight ¥102-¥104 band against the dollar for most of September, which suggests the market is pricing in a decision by the central bank to keep its powder dry on negative rates for now while signalling the potential for future cuts.

    That does not rule out disappointment, say analysts at Bank of America Merrill Lynch. Expectations for an immediate rate cut are lower than they were before the July BoJ meeting, but not zero: when the BoJ stayed on hold then, the yen surged 3 per cent against the dollar.