Asia/Pacific July 18, 2022 / 09:29 am UTC

BoJ Stays Firm in Ultraloose Commitment

By Cephas Kin Long Yung

Bottom line: The July 21-22 Bank of Japan (BoJ) meeting will reinforce the expectations of ongoing ultra-easy policy, as recent yield movements and inflation had market participants second-guessing the BoJ despite the commitment to QE on June 17. The BoJ is conducting fixed-rate repurchase operations (FRPOs) on every business day for 10yr JGBs to defend the target upper band of 0.25% and has successfully brought 10yr JGB yields lower. Moreover, the BoJ bought additional JGBs across the curve on June 15 to bring down the rising yields.

Figure 1: 10yr Japan and U.S. Yields (%)

Source: Datastream

The June 17 BoJ meeting sustained the commitment to QE with yield curve control (YCC), and this has been re-emphasized by Governor Haruhiko Kuroda during July. The JGB bond market is under heavy influence of rising yields for U.S. Treasuries with the Federal Reserve taking a more aggressive path of tightening on rising inflation. The benchmark 10yr JGB hovers around 0.25% despite the BoJ’s conducting FRPOs every business day to defend the target upper band of 0.25%. Combined with U.S. Treasury yields’ rotation lower, 10yr JGBs are slightly lower at around 0.23%. While there may be further turbulence in JGB yields, the BoJ has shown firm commitment in defending the target band and we do not expect any changes in the coming months. Kuroda firmly stated after March’s FRPOs that he has no plan to change the target band for 10yr JGB yields. He also commented on May 12 that the challenge for BOJ is not to curb inflation, but to pull Japan out of too-low inflation, which is significantly different from the stance of other major DM central banks, further supported by Cabinet Secretary Hirokazu Matsuno. Kuroda reinforced BoJ’s ultra-loose policy on July 10, by emphasizing the need to sustainably achieve a 2% inflation target. BoJ Executive Director Shinichi Uchida echoed the commitment by confirming that the 0.25% target band is not scheduled to change. Indeed, on June 15, the BoJ announced an additional purchase operation on JGBs across the curve, and we expect the BoJ to continue doing so if necessary, to keep yields in check.

Even as headline inflation broke above the 2% target to 2.5%, the BoJ will need to keep QE with YCC in place, as the major driver of recent inflation is unsustainably high prices of energy and food, not a sustained pickup in inflation, as evidenced by the 0.8% growth in national CPI ex fresh food and energy. The latest series of hikes from major central banks, especially the Swiss National Bank, had market participants questioning the BoJ’s commitment to YCC. But with both national and Tokyo CPI ex food and energy far away from the BoJ’s inflation target, the BoJ will continue to reinforce its dovish stance to remind the world that it remains committed to current policies. The latest comment from Kuroda ensured that there will be no change to current policies as long as he is in office, which is until April 2023. Our forecast for 2022 CPI inflation has been raised to 2.1% (due to surging energy price and short-term disruption in China), then we see 1% in 2023 as the short-term disruption fades. The BoJ has shown since 2013 that it can print money to buy huge amount of JGBs, and bond traders and hedge funds will not force the BOJ to change. 

The BoJ is unlikely to take any supplementary steps other than words to help meet the inflation target, despite the prospect that 2% core inflation is unlikely to be achieved in the coming year. Inflation expectations are so well-ingrained that the BoJ has found it persistently difficult to raise inflation expectations or for the economy to trigger bigger wage rises. However, there seem to be signs of life recently in inflation underneath the shadow of rising energy and input prices. Recent surveys suggest that 80% of large Japanese corporations are considering raising their prices, but any lasting impact can be told only in years rather than months. The BoJ has downplayed the potential impact of the Ukraine-Russia war and dismissed the idea that cost inflationary pressures will be sustainable without wage inflation. 

With Kuroda saying he expects Japan’s economy to return to growth in coming months as supply chain disruption peaks, the government’s fiscal policy stimulus is also filtering into the economy gradually. The government is also pushing for a narrowing of inequality through pay rises for low-paid workers rises and taxes on the wealthy, and we should see policy developments along these lines after the LDP’s performance in the upper house election in July. 

While multiple speakers from the BoJ and government had voiced their concern on rapid moves on the JPY, there seems to be little intention of an actual intervention. We feel that an effective intervention would be a joint one between the U.S. and Japan, which is far from being materialized as the Fed are hiking aggressively — despite some backing from U.S. Treasury Secretary Janet Yellen. The impact of the JPY decline on a TWI basis is not materially boosting the inflation outlook or hurting domestic markets, and that is why the authorities are not yet really sensitive.

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Analyst Declaration
I, Cephas Kin Long Yung, the lead analyst declare that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further declare that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.