Bank of Japan gives itself room for manoeuvre

The Bank of Japan (BoJ) is in perpetual easing mode. A quick glance at its latest forecasts underline just how elusive the 2% inflation target is. Prices are falling today and the policy committee expects inflation to reach only 0.7% y/y in (fiscal year) 2022. Of course, this monetary easing does not come without cost.

The side-effects of monetary easing

In 2018, the BoJ became much more vocal about the side-effects of monetary easing. Minutes of policy meetings regularly voiced concerns around government bond market functioning or financial market stability. In light of these concerns, the BoJ swiftly tweaked its yield curve control programme to allow wider fluctuations in government bond yields.

Last year, many of these concerns were thrown out the window due to the Covid-19 crisis with the BoJ ramping up quantitative easing in response. With the dust having settled (somewhat), the  BoJ decided it was once again appropriate to take stock, instigating a policy.

As signalled when the review was announced back in January, the BoJ remains happy with the overall framework of yield curve control and its asset purchase programme. But three changes were announced:

Removal of central guidance of ETF purchases

The first change was the removal of the central guidelines for ETFs and J-REIT purchases (at JPY6 trillion and JPY90 billion, respectively) keeping the upper limits of about JPY12 trillion and JPY180 billion. While ETFs and J-REITs make up 5% of the BoJ’s balance sheet, this is important for investors given the direct link to financial markets. This change was expected after various media reports in the last couple of weeks and ETF purchases have already slowed significantly over the last few months. 

BoJ to pay more to banks using lending programmes

Secondly, the Bank of Japan will set up the an Interest Scheme to Promote Lending. The BoJ will apply the short term policy rate to the balance held at the BoJ by banks. Given the short term rate is negative, this means paying interest and exactly how much will correspond to the amount of funds that have been provided through its lending programmes. This is a step to support banks that have been hurting from negative interest rates, though the scheme’s purpose (as communicated by the BoJ) was also to enable quicker interest rate cuts.

Tweak to band of yield curve control

Thirdly, the Bank of Japan said that the band for the 10-year government bond yield target would be +0.25% to -0.25%. While readers can argue whether or not this is indeed a change given the band was never written down, we can only assume that Kuroda has not waited almost two years to make a clarification.

Market participants, us included, had understood the band was plus or minus 20bps and the slight widening is intended to help government bond market functioning. As well as this, the BoJ introduced “fixed-rate purchase operations for consecutive days”. This effectively allows the BoJ to step in quickly to purchase bonds if yields rise significantly.

What does this mean for investors?

Big picture, the Bank of Japan made some tweaks to monetary policy in the wider context of being able to keep rates lower for longer. Most of these had been reported by the media in the last few weeks during which time the central bank will have welcomed a loosening of financial conditions thanks to the weaker yen.

If last couple of months is anything to go by, more flexibility in the short term likely means less rather than more when it comes to asset purchases. From this perspective, the Bank of Japan is taking small steps away from aggressive easing, while maintaining the option to ramp up easing if needed.

Stepping back, government bond yields in Japan are still to be capped at relatively low levels and Japanese equities continue to be underpinned by fundamentals.

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