Kazuo Ueda, the incoming Governor of the Bank of Japan (BoJ ), stated on Friday that the central bank should maintain ultra-low interest rates to support the fragile economy. Ueda cautioned against responding to cost-driven inflation with monetary tightening and emphasized the need to work out the right timing and means to tweak the BoJ ‘s bond yield curve control (YCC) policy. He said the recent inflation acceleration was driven largely by rising raw import costs, rather than strong demand, and that the outlook for Japan’s economy was highly uncertain.
Ueda’s emphasis on continuity in policy tempered market expectations that he might seek to make a hasty exit from the extreme stimulus of his dovish predecessor, Haruhiko Kuroda. “Japan’s trend inflation is likely to rise gradually. But it will take some time for inflation to sustainably and stably achieve the BoJ ‘s 2% target,” he said. The BoJ ‘s current policy is a necessary and appropriate means to achieve 2% inflation, although there are various side-effects emerging from the stimulus.
Ueda faces the challenge of phasing out the YCC policy, which has drawn public criticism for distorting market functions and crushing banks’ margins, as inflation exceeds the BoJ ‘s target. He said there were various possibilities on what YCC could look like in the future, adding that there were side-effects emerging from the policy, such as deteriorating market function. Ueda said the BoJ needed to monitor whether the measures it took in December, such as widening the band around its yield target, would help ease the side-effects.
Ueda’s caution against shifting policy too soon was echoed by Shinichi Uchida, the government’s deputy BoJ governor nominee, who said it was inappropriate to tweak ultra-loose policy just to deal with its side-effects. Targeting shorter-maturity bond yields, rather than the current 10-year yield, may be among options, though there are various other ideas for tweaking YCC in the future, Ueda said.
“If trend inflation heightens significantly and sustained achievement of the BoJ ‘s 2% target comes into sight, the central bank must consider normalising monetary policy,” Ueda said. In phasing out stimulus, the BoJ would do so by raising interest rates on financial institutions’ reserves parked with the central bank rather than selling bonds, he added.
Ueda will chair his first policy-setting meeting on April 27-28, when the BoJ will produce fresh inflation projections. The nominations need the approval of both chambers of the Diet, which are effectively done deals as the ruling coalition holds solid majorities in both.
The BoJ guides short-term interest rates at -0.1% and the 10-year bond yield around 0% under YCC, as part of efforts to sustainably achieve its 2% inflation target. Facing pressure from rising global interest rates, the BoJ was forced to raise in December the implicit cap for its 10-year yield target to 0.5% from 0.25%. Ueda said the BoJ ‘s current interest rate target levels, including the negative short-term rate, are appropriate. If Japan can foresee inflation reaching 2%, the target levels could be reviewed, but that won’t happen immediately.
Izuru Kato, chief economist at Totan Research and a veteran BoJ watcher, said the central bank may need to tweak YCC soon given the damage the policy has done to Japan’s bond market. “Ueda may ditch YCC to target a policy solely targeting short-term rates. I won’t be surprised if he makes such a move as early as April, when he takes up the job,” Kato said. The yen was volatile throughout the day and strengthened 0.03% to 134
