Money market watchers say Bank of Japan Governor Haruhiko Kuroda risks crippling the foundation of the nation’s financial system to achieve his inflation target.
The outstanding balance of interbank lending in the so-called call market tumbled 17 percent this year to 14.1 trillion yen ($138 billion) on April 11, the least since January 2003 when the central bank was conducting its first round of easing through bond purchases. The BOJ currently buys about 7 trillion yen of government bonds a month from financial companies, offers them 0.1 percent loans and buys treasury discount bills without any limit to boost money supply and keep borrowing costs low.
The decline in trading makes the money market vulnerable to shocks in times of crisis by increasing volatility, according to UBS AG. BOJ purchases have already eroded debt market trading, with 10-year government bonds untraded on April 14 for the first time in 13 years. Kuroda said the following day he won’t hesitate to adjust policy if needed as the central bank aims to boost inflation to 2 percent.
“The inflation target is the BOJ’s first priority, and the deteriorating functionality of the call market is unlikely to stop the BOJ,” said Izuru Kato, the president of Totan Research Co., a unit of money-market broker Tokyo Tanshi Co. “Call trading will remain stagnant.”
Banks have so much money on hand that they have no need to borrow in the call market, whose benchmark rate was the BOJ’s main policy tool until it switched to the monetary base last year. Financial companies held a record 134 trillion yen in their accounts at the BOJ as of April 16. The benchmark rate for overnight loans without collateral was at 0.07 percent on average this year, compared with the mean of 0.15 percent for the past decade.
Twenty-six of the 36 economists surveyed by Bloomberg News expect the BOJ to add to easing by July through expanding monthly government bond purchases, as well as buying more exchange-traded funds and real-estate investment trusts. Policy makers will release updated forecasts on inflation and economic growth after they next meet on April 30.
“The BOJ has no other choice but to add to stimulus at some point,” said Takafumi Yamawaki, the Tokyo-based chief rates strategist at JPMorgan Chase & Co., one of the 23 primary dealers obliged to participate in government debt auctions. “But I’m skeptical that they can come up with additional measures that have a big impact. I think it would end up being small-scale easing.”
In addition to government bonds, the BOJ also buys an amount of treasury discount bills that’s not predetermined. It held 44.2 trillion yen of such securities as of April 10 after buying 7.67 trillion yen on average every month over the past year. The central bank can only increase its holdings of treasury bills up to 60 trillion yen, leaving it little scope to buy more, according to estimates by the Bank of Tokyo-Mitsubishi UFJ Ltd.
Kuroda told Prime Minister Shinzo Abe on April 15 that the BOJ won’t hesitate to adjust monetary policy if needed. The central bank refrained from taking additional steps a week earlier, sending Japan’s Topix index of shares to its biggest two-day decline in three weeks.
“I take it that Kuroda indicated he will fine-tune his policy” rather than expanding stimulus, said Takahiro Sekido, a Japan strategist in Tokyo at the Bank of Tokyo-Mitsubishi UFJ, who formerly worked at the central bank. “The BOJ is likely to extend maturities that it buys while maintaining the size of its monetary-base target. That won’t be additional monetary easing for Kuroda.”
The 10-year yield was at 0.6 percent, the lowest globally. The benchmark yield swung from an all-time low of 0.315 percent on April 5, 2013, the day after Kuroda announced unprecedented monetary stimulus, to as high as 1 percent in May. The yen traded at 102.53 against the dollar as of 4:05 p.m. in Tokyo today.
The benchmark rate for overnight loans without collateral slid 2.5 basis points on March 31, the most since January 2013. It jumped 2.1 basis points the next day.
“Reduced trading volume lowers liquidity, leaving the market more vulnerable to a sudden surge in volatility,” said Yusuke Ikawa, a rates strategist in Tokyo at UBS.
Japan’s first default on interbank loans -- by Sanyo Securities Co., which filed for bankruptcy in 1997 -- contributed to a banking crisis that led to the collapse of Yamaichi Securities Co., then the nation’s fourth-biggest brokerage.
“The call market is the most fundamental part of the banking system,” said Tetsuya Inoue, a former BOJ official who is now chief researcher for financial technology and markets at Nomura Research Institute Ltd. in Tokyo. “It supports daily funding for banks and also signals professionals’ views on future rates, but these functions are almost lost. The BOJ must be thinking it’s an inevitable side-effect.”