Bank of Japan Raising QE Exit Provisions Seen as Drop in Bucket

  • Kuroda has said balance sheet concerns won't stop more easing
  • `BOJ needs to set aside more funds,' says NLI Research's Ueno

The Bank of Japan is seeking to cover the cost of tapering stimulus by keeping as much as half the profits on its record bond holdings. Barclays Plc is among lenders warning that’s not enough.

At issue is a potential surge in the cost of interest payments on commercial lenders’ excess reserves. While the rate on those deposits is 0.1 percent now, it will rise as the BOJ gets closer to its 2 percent inflation target and starts tightening. Barclays estimates the bill would reach 4 trillion yen ($32.5 billion) a year by the end of 2017, assuming a rate of 1 percent.

The central bank announced the change to its accounting rules on Friday and, based on its latest results, the monetary authority would be able to set aside about 400 billion yen annually. Since Governor Haruhiko Kuroda launched quantitative easing in April 2013, Japanese lenders’ excess reserves at the BOJ have more than quintupled to about 215 trillion yen.

“If you think about it rationally, it’s not nearly enough -- like a drop of water on a hot stone,” said Kyohei Morita, a Tokyo-based economist at Barclays. “The BOJ will need to tap its own capital to cover the losses. It’s going to end up in a very difficult spot.”

Even with the deposit rate near zero, the ballooning of excess reserves as a byproduct of quantitative easing boosted interest payments by more than half to 106 billion yen in the six months to September from a year earlier. By contrast, the BOJ’s reserve fund hasn’t grown from 2.2 trillion yen since at least 2008, according to data going back to that year posted on the central bank’s website.

Record Holding

Kuroda said last month that concerns about the balance sheet won’t stop additional easing, and that he doesn’t see issues arising in the financial system. The central bank has already cornered 28.5 percent of the Japanese sovereign bond market with a program that has scope to snap up every new note the government issues.

Mizuho Securities Co. says tapering probably won’t occur until after April 2017, when the government will raise the consumption tax to 10 percent. A similar increase to 8 percent in April 2014 sent the economy into recession.

“In an ideal situation, the BOJ should start tapering soon and then gradually raise interest rates to avoid crushing its finances,”said Noriatsu Tanji, a strategist at the brokerage. “The longer quantitative and qualitative easing lasts, the more bonds the BOJ will buy, and that means higher interest payments when it starts tapering.”

Distant Goal

Despite more than two years of record bond purchases, the BOJ’s targeted measure of inflation has been below zero for three straight months amid lower oil prices, and the economy has again slumped into recession.

While Kuroda has reiterated his confidence in reaching the price goal in or around the period between October 2016 to March 2017, economists are virtually unanimous in predicting failure. The central bank extended its deadline by six months on Oct. 30, the second delay this year.

“Nobody in the market thinks the BOJ will reach its 2 percent inflation target within the next fiscal year,” said Hidenori Suezawa, an analyst at SMBC Nikko Securities Inc. in Tokyo, referring to the 12-month period from April 2016. “If QQE is extended until fiscal 2017, and the BOJ ends up owning half of the bonds outstanding, then an exit would mean a huge loss. The higher the mountain, the deeper the valley.”

Falling Yield

The central bank’s predicament will be exacerbated by losses on its Japanese government bond investments, as higher rates push yields up and prices down. Its holdings of exchange-traded funds and real-estate investment trusts will also be susceptible to market swings, and Deputy Governor Kikuo Iwata has said they could fall below book value.

Quantitative easing helped push the yield on 10-year JGBs to a record low of 0.195 percent in January. It was 0.315 percent on Wednesday in Tokyo, the lowest globally after Switzerland.

“The BOJ needs to set aside more funds,” said Tsuyoshi Ueno, a senior economist at NLI Research Institute in Tokyo. “If the BOJ raises rates suddenly, it will faces trillions of yen in losses -- and the market is becoming aware of that.”

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