Bank of Japan straps in for bumpy ride

Following a series of media reports last week suggesting policy changes from the Bank of Japan (BoJ), the central bank meeting became a highly anticipated one. In particular, markets speculated that the BoJ would make changes to its yield curve control policy, which guides the 10-year government bond yield to “around zero per cent”.

Our expectation was for the BoJ to remain dovish, given the disappointing inflation developments this quarter. In line with this, there were no major changes to the overall monetary policy framework; the short-term policy rate was kept on hold at -0.1%, the 10-year government bond yield target kept at “around zero per cent” alongside an unchanged ¥80tn annual pace of Japanese government bond (JGB) purchases.

However, there was a series of small tweaks. First was the addition that “yields may move upward and downward to some extent mainly depending on developments in economic activity and prices”, allowing larger fluctuations in JGB yields. Forward guidance was also strengthened, adding that current low rate policy would be maintained for “an extended period of time”.

Wording around the ETF purchase programme was also tweaked to allow more flexibility on the number of purchases. In addition, likely done to help alleviate some pain on the banks, the policy rate balance to which the negative interest rate is applied will be lowered from August this year.

Changes to the accompanying quarterly outlook report were as we expected. The inflation forecast was revised down (by 0.2% y/y to 1.1% for FY18 and also lower for 2019[1] and 2020 to 1.5% and 1.6%, respectively). The growth outlook was also slightly lowered for FY18 by 0.1% to 1.5%, but kept unchanged in 2019 and 2020.

The concern for markets going into the meeting was that the BoJ would effectively tighten policy, despite an ongoing failure to meet the inflation target, due to concerns about the negative side-effects of easing. This would have signalled a clear change of tone from the BoJ and mark a step towards normalising policy.

Instead what we saw is that the BoJ took a series of small measures to strengthen its existing monetary policy framework - an implicit acknowledgement of how far it is from reaching the 2% inflation target. In short, the BoJ is strapping itself in for a longer (and bumpier) ride.

[1] Inflation forecasts from 2019 exclude the consumption tax hike.