Japan Joining Global Bond Rout as BOJ Shifts on Inflation Target

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Japan's Consumer Prices
Consumer prices rose only 0.2 percent in March from a year earlier after no increase in February, excluding the effect of a sales-tax increase last April. Photographer: Noriko Hayashi/Bloomberg

The Bank of Japan’s equivocation on its inflation target is adding to the shifting global monetary policy picture that has sparked a sovereign debt rout.

Japan’s 10-year yield has climbed almost 10 basis points since BOJ Governor Haruhiko Kuroda said April 30 that he sees the price goal being reached around the first half of the 2016 fiscal year. When Kuroda introduced his record bond-buying plan in April 2013, he said he expected the goal would be reached in about two years. The change in tone is an admission of failure that suggests the need for further easing, which is technically difficult and requires a new policy regime, according to Tokai Tokyo Securities Co.

“It’s difficult for the BOJ to meet its inflation target and a failure of the current policy framework will spur talk of a technical exit,” said Kazuhiko Sano, the chief bond strategist at Tokai Tokyo who correctly predicted Japan’s 10-year yield would fall to 0.25 percent by March. “The BOJ will need to overhaul the fundamental framework of its quantitative and qualitative easing.”

The whispers of unquiet in Japan’s markets coincided with a slump in bonds across the world on prospects that U.S. interest rate increases will kill off the bull-run in sovereign debt that took yields to unprecedented lows. Benchmark Japanese securities had their biggest decline in three months on Thursday after Federal Reserve Chair Janet Yellen said on May 6 that yields on Treasury bonds are too low.

Illiquid Market

Growth in Japan’s monetary base slowed to 35 percent in April after peaking at 56 percent in February last year even as the BOJ kept a pledge to keep expanding it by 80 trillion yen ($667 billion) annually. Despite record stimulus, the BOJ’s key inflation gauge eked out only a small gain in March as the central bank blamed falling oil prices for the slump.

The BOJ’s bond buying is turning the world’s second-biggest debt market into a vicious circle of illiquidity. The government plans to sell 152.6 trillion yen of bonds this fiscal year at auctions the central bank can’t bid in. The BOJ then holds its own tenders to buy from the market about 90 percent of monthly issuance.

The yield on the 10-year bond was little changed at 0.425 percent as of 11:06 a.m. in Tokyo, according to Japan Bond Trading Co., the nation’s largest inter-dealer debt broker. A basis point is 0.01 percentage point.

Commitment Key

Consumer prices rose only 0.2 percent in March from a year earlier after no increase in February, excluding the effect of a sales-tax increase last April. The BOJ on April 30 cut its estimate for core inflation to 0.8 percent for the year through March from a January forecast of 1 percent.

Kuroda said last week there’s no change to the central bank’s pledge to meet its objective as soon as possible even as he said there’s been a delay in reaching the goal. Projections for CPI tumbled after the BOJ’s policy meeting on April 30.

“Key here is that the BOJ upholds its commitment by seeing a 2 percent inflation for fiscal 2016 and 2017 during its projected period,” said Chotaro Morita, the chief rates strategist in Tokyo at SMBC Nikko Securities Inc. “The BOJ is fading out of the two-year commitment and shifting to promising to achieve the goal as early as possible.”

The BOJ may find it harder to buy bonds as supply tightens in the secondary market, according to Tokai’s Sano.

Excessive Buying

The central bank has avoided under-subscriptions at its bond buying operations as institutional investors including the $1.2 trillion Government Pension Investment Fund and Japan Post Bank reduce JGB holdings in line with Kuroda’s efforts to encourage a shift toward risker assets.

If the BOJ determines that there is a time lag between its bond purchases and increases in consumer prices, it will keep buying notes until inflation picks up, according to Hideo Kumano, the chief economist at Dai-ichi Life Research Institute Inc. in Tokyo and former central bank official. Such a move will harm markets, he said.

For more, read this QuickTake: The Trouble With Falling Prices

“The BOJ gave up on the two-year commitment and broke the rule of the initial quantitative and qualitative easing,” Kumano said. “A regime turnaround brings instability and leads to higher volatility.”

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