Kuroda’s Journey From Shock-And-Awe to Bond Market Fine-Tuning

BOJ Shifts Policy Framework: What Does It Mean?
  • BOJ shifts focus to yield curve, resists calls for bold moves
  • Analysts urge Abe to step up as central bank options dwindle

Bank of Japan Governor Haruhiko Kuroda stormed onto the global stage back in 2013 with the subtlety of a Metallica concert, electrifying markets with a shock-and-awe monetary expansion powered by increased purchases of Japanese government bonds.

On Wednesday, Kuroda seemed a little bit more like a jazz musician, riffing variations on established themes. It’s not the sort of stuff that quickens the hearts of investors.

Haruhiko Kuroda on Sept. 21.
Haruhiko Kuroda on Sept. 21.
Photographer: Kiyoshi Ota/Bloomberg

The BOJ refrained from another interest rate cut and instead pledged to bolster the long-end of the bond market’s yield curve. It’s a move that will help Japanese banks, pension funds and insurers cope in a less-than-zero rate environment, but disappointing to economists who had hoped for more dramatic action. At the same time, the central bank pledged to keep its monetary base -- bank cash reserves and currencies in circulation -- growing until after inflation exceeds a 2 percent target that was set back in 2013.

After years of sustained quantitative easing (QE), followed by a surprise decision in January to adopt a negative interest rate policy, Kuroda is now shifting his focus to the collateral effects of aggressive monetary easing. "We think central banks are finally waking up to the limits and risks of prolonged QE and negative interest rates policy," said Alberto Gallo, head of macro strategies at Algebris Investments in a note to clients.

Deflation Fight

Kuroda deserves a lot of credit for keeping Japan from falling into a deflationary spiral. Economic growth, however, has been uneven under his watch thanks at least in part to an ill-timed sales-tax hike by Prime Minister Shinzo Abe’s government in 2014 year that pushed the economy into a recession. 

The BOJ’s 2 percent inflation target has also proven elusive thanks, in part, to a historic slump in energy prices in a very energy-dependent economy. Despite all the cheap money, companies aren’t borrowing and investing at impressive levels, nor are consumers spending robustly. The central bank’s bond-buying binge has blown out its balance sheet, raising questions about its sustainability.

Click here for a QuickTake Q&A on why the BOJ’s targeting the yield curve

"It’s hard not to see the BOJ statement as a further sign that it it is running out of ideas," said George Magnus, London-based senior independent economic adviser to UBS Group AG. 

Instead, analysts say the focus needs to shift onto areas of economic policy well beyond the central bank’s control. Rather than more bond buying, Abe’s government needs to grasp thorny structural reforms like changes to labor market laws and steps to boost competition. The need for these sort of changes was given a new sense of urgency when a new round of fiscal stimulus announced by Abe in August largely underwhelmed.

"I do not think that the solution to Japan’s economic stagnation lies with changes in monetary policy," said Barry Bosworth, a senior fellow at the Brookings Institution in Washington. "The larger problem is in the weak level of corporate investment, which when combined with high retained earnings has a major depressive effect on the economy."

With little political appetite for those measures, for now at least the focus remains on what the BOJ does next.

The Japanese central bank said its target for expanding the monetary base through asset purchases, previously set at 80 trillion yen ($780 billion) annually, may now fluctuate in the short term to enable policy makers to control bond yields.  It also scrapped a target for the average maturity of its government bond holdings. Both moves will help the central bank manage the impact of lower long-term yields on Japanese banks

As well, the BOJ released an comprehensive assessment of the central bank’s policy maneuvers which broadly gave a thumbs up to its actions, while acknowledging the side effects of low yields and negative interest rates.

Elusive Goal

On paper at least, the changes introduced by the BOJ are dramatic in one sense. It’s a sign of the times that a developed central bank is actually courting inflation. Likewise, the bank is showing some flexibility by shifting its focus to the yield curve and recognizing the side effects of negative rates.

Problem is, inflation is nowhere near 2 percent so its credibility is on the line if it continues to come up short. The BOJ economists insist that core inflation is now firmly entrenched in positive territory and blames external factors like the price of oil for keeping prices down. That’s true, but doesn’t mean they are any close to the target.

Japan’s core consumer prices fell in July at the fastest pace since Kuroda took the helm of the BOJ in March 2013.

Shane Oliver, head of investment strategy at Sydney-based AMP Capital Investors Ltd., said more dramatic monetary measures are needed, including the direct financing of fiscal stimulus by the central bank, the so-called helicopter money option. "I am a bit skeptical that without the adoption of helicopter money, the BOJ may continue to struggle to meet its inflation target," said Oliver.

Similarly, the promise to target the yield curve leaves wriggle room for how exactly the bank will implement that promise. A decision not to cut negative rates further could be seen as an acknowledge of the negative side effects of that policy.

JGB King

Markets took the BOJ’s decision in their stride. The yen’s move against the dollar was muted on Wednesday, though it remains up against the dollar by around 17 percent. It traded at 101.41 at 7:49 p.m. in Tokyo. The Topix stock index rose and 10-year government bond yields hit positive territory for the first time since March.

Kuroda used a later press conference to make clear that the bank is far from running low on ammunition and promised to unleash more stimulus if it is needed. The BOJ may yet decide to expand JGB purchases or cut the negative rate further as soon as its next meeting ending on Nov. 1.

Still, those pledges are starting to wear thin considering that the BOJ now owns more than a third of outstanding JGBs. The pace of its buying is draining the market of supply, and many commercial banks are running out of JGB inventory to sell.

"The BOJ placed a bet that it could change consumption- and investment-related behavior through monetary policy, and failed," said Jun Okumura, visiting scholar at Meiji Institute for Global Affairs in Tokyo.

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