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Japan’s Central Bank Is Looking Increasingly Cornered

Toru Fujioka

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Bank of Japan Governor Haruhiko Kuroda, who made his mark pursuing aggressive monetary stimulus policies, is under fresh pressure by financial markets to return to the fight.

Government bond yields are falling through the floor of the central bank’s target range, the yen is hovering at the limit of companies’ comfort zones and inflation is weakening again.

Add the fact that other central banks are stepping up to support their economies and Kuroda has no shortage of reasons to do likewise. Among the options are lowering the negative short-term interest rate, increasing asset purchases or widening the trading range around its long-term yield target.

“The BOJ has probably already made up its mind that it has to ramp up its easing,” said Masaaki Kanno, chief economist at Sony Financial Holdings and a former BOJ official. “The BOJ can’t take the risk of watching the yen strengthen without doing anything when the Fed and ECB are going to act.”

Economists including Takeshi Yamaguchi at Morgan Stanley see a lowering of the short-term negative rate among the most likely moves by the BOJ, should it take action. Merely widening the trading range around the 10-year yield could encourage market players to take on the new floor and force yields even lower, former BOJ board member Sayuri Shirai said, also pointing to a negative rate cut should the yen strengthen further.

Japan’s central bank has been reluctant to take further action out of growing concern that its yield curve-control program is squeezing profits at commercial banks and distorting markets. Feeble inflation by itself hasn’t been enough of a factor for the central bank to add extra ammunition, even though the BOJ sets price growth as the main target of its easing program.

But now the limits of its YCC program are becoming more apparent as the BOJ faces increasing difficulty in stopping the downward movement in 10-year government debt yields. While Kuroda said he the trading range around the yield target shouldn’t be taken too literally, the continued falls are straining the limits of interpretation.

The BOJ has scaled back its bond purchases further in recent days, trimming its buying plans for September and carrying out a smaller bond operation on Monday. Still, the yield on the benchmark 10-year JGB is -0.265%, seen well below the loose trading range around zero permitted by the central bank.

Here’s How Tokyo Traders See the BOJ Stopping the Yield Drop

BOJ moves to cut its bond buying at a faster pace run the risk of being interpreted by market participants as a tapering of stimulus. That can be a trigger for more yen strength when the murky global outlook is already driving safe-asset demand into Japan’s currency.

The yen touched 104.46 per dollar last week, its lowest level since November 2016. That’s above the 109.35 expected by Japan’s big manufacturers for this fiscal year, according to central bank’s quarterly Tankan survey, and those companies usually take a conservative view on the exchange rate to guard against any strengthening of the currency.

While the economy is far from crisis mode despite the murky global outlook, a looming sales tax could remove the prop of domestic consumption that has helped keep the economy expanding.

Expected rate cuts by the Fed and the ECB this month could help push up the yen, adding to the pressure cooker status of the BOJ’s predicament.

From Leftfield

Takeshi Minami, chief economist at Norinchukin Research Institute, said that the last thing the BOJ wants is to lag behind its global peers as it did during the global financial crisis in 2008. Late action then lit a fire under the yen and strengthened deflationary forces in the economy.

Kanno sees Kuroda more likely to take a two-stage approach to easing. The former BOJ economist expects the bank to announce another comprehensive assessment this month and bolster stimulus in October in tandem with a government fiscal package. The BOJ used a comprehensive assessment previously to launch the YCC program and explain away the failings of its earlier quantitative easing and negative rate policy.

“I get the feeling that BOJ policy makers will be putting together something completely new that market economists have yet to imagine. That’s what the record shows,” Kanno said.

What Our Economists Say

“Since three rate cuts by the Fed this year are already priced into currency and bond markets, the yen is unlikely to strengthen much beyond 105 to the dollar. It’s therefore still not our base scenario that the BOJ will take additional action in September.”

--Yuki Masujima, economist

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To contact the reporter on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Paul Jackson, Henry Hoenig

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