Bank of Japan straps in for the long haul (again)

As the Federal Reserve settles in to Average Inflation Targeting, the Bank of Japan (BoJ), will likely be reminded of its own inflation overshooting commitment more than four years ago. Of course, for Japan, it did not work.

Since then, the BoJ has introduced yield curve control and also more forward guidance around interest rates being lower for longer. Alongside this, the quantitative easing (QE) programme has ballooned. The balance sheet is now 116% of GDP and the BoJ owns 41% of the Japanese government bond (JGB) market.

Not without controversy, the QE programme has also ventured into corporate bonds, commercial paper, real estate and equities. 

Review to focus on sustainability, not framework

Today, the Bank of Japan signalled that another review of monetary policy is needed. Though BoJ Governor Kuroda was quick to reassure investors that this is not going to be a monetary policy overhaul. He stressed that there were no plans to tweak the central bank’s yield curve control policy or abandon negative interest rates. Rather, the communication suggested that the focus of the review was making monetary policy more “effective and sustainable”. 

This year, Covid-19 has been a significant external shock to Japan which was already suffering with low inflation. Prices are now falling by -0.9% year-on-year and while it is too early to declare the return of genuine deflation in Japan, the risk is high. This not only poses a challenge for the Bank of Japan given its limited ammunition, but also highlights the need for monetary easing to be sustainable in the long run and be considered in the wider context of financial stability.

We will have to closely watch the BoJ for clues of what may lie ahead, particularly as central banks more widely are expected to play a significant role in bond markets for a considerable period. The findings of the review will be announced in March. Stay tuned.

Corporate bond QE and loan programme extended

Aside from this, there were two other changes announced by the BoJ.

The first was the extension of part of its QE programme. The purchases of commercial paper and corporate bonds were extended by six months to next September. Though significant in the context of the relatively small domestic market, for investors thinking about global liquidity, it important to bear in mind that corporate bonds and commercial paper form less than 2% of the BoJ’s balance sheet. Instead, the purchases of government bonds – and more recently the introduction of the special coronavirus loan programmes – are the major drivers of the BoJ’s balance sheet today.

Moving on then, the second change was an extension of the coronavirus loans. This, again, was by six months to September. The programme provides cheap loans to banks to help finance small companies through the pandemic.

To encourage take-up of the scheme, the BoJ also removed the upper limit of ¥100bn per institution. This should boost the BoJ’s balance sheet yet again, or rather reduce the tapering off of assets in the second half of next year.

No changes to yield curve control and the rest of QE

Otherwise, there were no major changes to monetary policy. Yield curve control remained unchanged; 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”. Guidance around interest rates was also unchanged. On the rest of QE, the guidance around the purchases of JGB purchases, ETFs and J-REITs were also unchanged.

Investors give their verdict after the Fed, ECB & BoJ

Investors seemed to shrug off the announcements of the meeting. The yen – now the main driver of monetary conditions in Japan – did not weaken and actually strengthened slightly.

This leaves us taking stock of the last couple of weeks which have brought three meetings from the major central banks in the Eurozone, the US and Japan. Like teachers marking students in end of year exams, investors have been busy examining the announcements from each one. The students seems to be working hard, but the market reaction shows standards are getting higher.

The verdict seems to be: must work harder.

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