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Bank of Japan Enlarges Toolkit as Inflation Goal Recedes

Bank of Japan Governor Masaaki Shirakawa
Masaaki Shirakawa, governor of the Bank of Japan. Photographer: Haruyoshi Yamaguchi/Bloomberg

The Bank of Japan added to its toolkit by abandoning a minimum return on bonds it purchases, a step that may ensure it meets targets for adding stimulus to the economy even as a goal of ending deflation remains out of reach.

The BOJ scrapped the requirement for regular purchases of government debt, currently set at 1.8 trillion yen ($23 billion) a month, and for notes that it accumulates under a 55 trillion yen asset-purchase fund. Policy makers also yesterday expanded the asset program by 10 trillion yen.

A report today showing a slide in exports underscored the need for steps to support an economy where growth has now paused, according to the BOJ. The slowdown has contributed to a surge in demand for government debt as a haven that sometimes left the central bank unable to complete planned bond purchases in recent months. Three-year notes yield just 0.1 percent.

“The Bank of Japan really wanted to smooth the way for carrying out bond purchases, to make sure that asset purchases can be completed,” said Shogo Fujita, chief Japanese bond strategist at Bank of America Merrill Lynch in Tokyo. “It also opened the door for negative rates.”

Exports fell 5.8 percent in August from a year earlier, the third straight decline, the Finance Ministry said in Tokyo.

Stocks Fall

The Nikkei 225 Stock Average fell 0.7 percent as of 11:30 a.m. in Tokyo after yesterday climbing to the highest level since May because of the central bank’s easing, which was forecast by only five of 21 analysts surveyed by Bloomberg News. The yen was little changed at 78.39 per dollar.

Yields on benchmark 10-year government bonds were today at 0.8 percent. Two-year yields were at 0.09 percent.

Central banks across the globe have had to come up with new tools after they lowered benchmark rates toward zero. The U.S. Federal Reserve last week unveiled a third round of so-called quantitative easing, committing to buy $40 billion of mortgage debt a month. Denmark has experimented with negative interest rates, while Switzerland capped its exchange rate.

In Japan, the central bank held 10.2 percent of government bonds as of the end of June, the highest proportion since 2006, the BOJ said in a report today.

Economic Challenges

Japan’s challenges span entrenched deflation, tensions with China, nuclear plant shutdowns, weakness in exports and the risk the government will run out of money because of a parliamentary deadlock. Prime Minister Yoshihiko Noda said last week that an extra budget will be needed. Consumer prices excluding fresh food fell 0.3 percent in July from a year earlier, the sharpest decline since March 2011.

The Bank of Japan downgraded its economic assessment yesterday, saying growth has “come to a pause” while overseas economies have moved “somewhat deeper into a deceleration phase.” A manufacturing index for China today indicated a contraction, in a preliminary reading for this month.

JPMorgan Securities, Credit Suisse Group AG and BNP Paribas expect Japan’s economy to contract this quarter after growth slowed to a 0.7 percent annual pace in the previous three months. Lawmakers have pushed for bolder action from the BOJ as a target of 1 percent inflation remains distant.

With the BOJ saying it anticipates consumer prices will remain flat for the time being, “this elevates our concern that the bank will not be able to meet its long-term inflation goal,” HSBC Holdings Plc analysts wrote.

Losing Traction

The central bank removed the yield requirements after its stimulus efforts had started to lose traction in markets.

So-called rinban purchases of government debt failed to reach BOJ targets twice since May, which hadn’t happened since 2006. Separate funding operations and buying tied to the central bank’s asset-purchase program also ran short of securities to purchase, short-circuiting the primary method for injecting money into the financial system.

The decision to purchase Japanese government bonds without regard to yield should have an impact on financial markets, central bank Governor Masaaki Shirakawa told reporters yesterday.

“If Europe’s debt crisis worsened in coming months, negative yields could become possible in Japan as investors sought out less risky assets,” said Masaaki Kanno, chief economist at JPMorgan Securities Japan Co. and a former central bank official. “For now, financial markets in Europe are stabilizing, so negative yields are unlikely.”

European Stresses

In the euro area, negative yields this year highlighted the stresses which prompted European Central Bank President Mario Draghi’s Sept. 6 pledge to buy a potentially unlimited amount of securities.

Germany yesterday sold two-year notes with a positive yield for the first time since June 20. The nation auctioned the securities at an average yield of 0.06 percent, the Bundesbank said, up from zero at the previous sale on Aug. 22.

In Japan, Finance Minister Jun Azumi said yesterday’s easing was bolder than expected and “very much welcomed” by the government.

“Whether central banks intend it or not, there is a competition for loosening monetary policy around the world,” said Izuru Kato, chief market economist in Tokyo at Totan Research Co. and one of the analysts who forecast easing. Shirakawa doesn’t want to be seen as “reluctant to compete in the race” because of the risk of yen gains that will hurt the economy, Kato said.

Yesterday’s 10 trillion yen increase is made up of 5 trillion yen of government bonds and 5 trillion yen of treasury bills. The central bank pushed back the completion of purchases under the asset program to December 2013 from June 2013.

Likely Triggers

“The BOJ appears to be moving away from its cautionary stance and into a new age of pre-emptive action,” HSBC economists Izumi Devalier and Fred Neumann wrote in a note after the announcement. “Likely triggers include recent unprecedented actions by the Fed and ECB, as well as a potentially new dovish bias caused by the addition” of two new non-career BOJ board members, they wrote.

Takehiro Sato, a former economist at Morgan Stanley who joined the board in July, said July 24 that buying foreign bonds was one option for the central bank. Takahide Kiuchi, a fellow newcomer to the board, said the same day that the bank may need to consider “new forms of monetary easing.”

Japan’s weakening recovery faces an added threat from a territorial dispute with China, Japan’s biggest export market. Toyota Motor Corp., Honda Motor Co. and Nissan Motor Co. production at some plants in China has been affected by protests.

The yen strengthened to a seven-month high of 77.13 per dollar on Sept. 13, after the Fed announced its plan for a third round of quantitative easing.

“We are concerned about an increase in the speed of yen appreciation, and our sense of crisis is intensifying,” Akio Toyoda, chairman of the Automobile Manufacturers Association and chief executive officer of Toyota, said Sept. 14. “We strongly hope the government and the BOJ can cooperate closely and act swiftly to correct a historically strong yen level.”

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