BOJ Plans to End Easy Policy Next Year, but Requires Some Good Fortune – Reuters

By Leika Kihara

TOKYO – Bank of Japan Governor Kazuo Ueda plans to gradually unwind the central bank’s ultra-loose monetary policy, aiming for an exit from the long-standing accommodative stance sometime next year. This approach, while necessary, poses significant risks and demands careful execution.

Key to Ueda’s strategy will be navigating various global uncertainties, such as conflicts in the Middle East and concerns over the economic stability of the U.S. and the growth trajectory of China. Insights into Ueda’s plans come from discussions with multiple sources familiar with the BOJ’s internal considerations, including government officials who interact closely with the bank.

Since beginning his tenure in April, Ueda has maintained a gradualist approach, continuing the dovish language established by his predecessor. He has reiterated the commitment to keep monetary policy loose until the BOJ’s 2% inflation target is sustainably reached. However, with inflation surpassing the 2% mark for over a year, Ueda has begun to roll back the stimulus measures from the previous regime, starting with a shift in April to remove the commitment to maintain low interest rates.

Ueda is aware of the delicate balance required, as even minor adjustments could lead to increased bond yields and disrupt the BOJ’s plans for a soft landing. According to one anonymous source, the bank’s main message is to uphold ultra-loose policies, even if it seems at odds with their actions. Another source noted that the BOJ likely aims to wait until at least spring next year before normalizing its policy, making a dovish guidance sensible under current economic uncertainties.

YEN RISKS

A significant concern for the BOJ is the weakening yen, a consequence of its persistently low rates. A depreciating yen risks escalating import prices and increasing the cost of living for households, potentially intensifying political pressure for an earlier exit from easy monetary policy. Despite this, Ueda is anticipated to approach the exit cautiously, prioritizing a stable policy framework over immediate currency stabilization.

Experts suggest that the BOJ’s preference is to avoid abrupt policy shifts, learning from past experiences. In response to rising bond yields, the BOJ recently adjusted the cap for the 10-year yield from 0.5% to 1% as part of a measured adjustment in its yield curve control policy. Moreover, the bank has signaled a relaxation of its previous strict bond yield limits, further indicating a shift in direction.

The next focus for the BOJ is to terminate its negative interest rate policy, pushing short-term rates from -0.1% toward zero. Ending negative rates would be a significant step, marking a transition towards a more neutral policy stance that directly influences the central bank’s policy rate.

Many policymakers within the BOJ anticipate that significant progress on this front may occur around spring next year, particularly if wage negotiations yield pronounced pay increases. A shift in BOJ policy, especially as it diverges from a globally hawkish narrative, could lead to substantial market reactions, including a repatriation of Japanese investments.

However, even small indications of a potential exit could trigger a sell-off in the bond market, inflicting severe losses on investors and complicating the management of Japan’s substantial public debt. With many hurdles remaining, there is a consensus that the BOJ should avoid raising expectations for an imminent policy shift.

Given the potential costs of rising market rates, the most plausible exit scenario is expected to entail the end of both yield curve control and negative rates while maintaining a loose framework for market interventions in case bond yields surge unexpectedly.

Fresh estimates from the BOJ continue to indicate that inflation is likely to remain significantly above 2% this year and into next, raising questions about Ueda’s assertion that a sustained achievement of the inflation goal is just around the corner.

The potential for a sharp decline in the yen and an inflation surge could pressure the BOJ to act sooner than preferred. A former central bank official noted that the BOJ may not have the luxury of waiting for an optimal time, suggesting that Ueda is likely acutely aware of the evolving economic landscape.