TOKYO The Bank of Japan vowed on Wednesday to take necessary steps to reduce volatility in bond markets that has threatened to jeopardize the government's fight to end deflation and revive growth.
The central bank upgraded its assessment of the economy for a fifth straight month, saying it "has started picking up," as Prime Minister Shinzo Abe's policy prescription of aggressive fiscal and monetary stimulus has boosted sentiment and a weaker yen has halted a decline in exports.
As expected, the policy board voted unanimously to stick with April's massive quantitative easing, in which it pledged to vanquish 15 years of entrenched deflation by doubling its Japanese government-bond holdings in two years as it expands the supply of money at an annual pace of 60 trillion ($583 billion) to 70 trillion yen.
While the government's aggressive policies have sent stocks soaring to 5-1/2-year highs and the yen tumbling to a 4-1/2-year low against the dollar, turmoil in the Japanese government-bond market in recent weeks has cast a cloud over the effectiveness of the BOJ's easing, a key element of "Abenomics" that is showing early signs of lifting the world's third-largest economy from a two-decade funk.
BOJ Governor Haruhiko Kuroda vowed to take steps needed to reduce volatility in the JGB market, but he disappointed some bond investors by sticking with the strategy of leaving it to BOJ bureaucrats to address the problem by tweaking the bank's market operations.
Indeed, Kuroda played down any economic impact from the bond moves, where the benchmark yield recently had its biggest three-day spike in a decade as investors struggle to cope with the overwhelming impact of the BOJ's radical money expansion.
"I don't think the recent rise in yields is having a big impact on the economy," Kuroda told a news conference after a two-day BOJ policy meeting.
"We will continue to monitor market moves and respond with flexibility in the pace and maturities of bond purchases and in market operations."
Kuroda emphasized that these adjustments would not change the BOJ's commitment to buying about 50 trillion yen in government debt a year.
The purchases, running about 7.5 trillion yen a month, were intended to lower rates across the yield curve. But despite the BOJ buying the equivalent of 70 percent of new government-debt issuance, the policy has caused yields to rise erratically on worries that the purchases are distorting the market and sapping liquidity, according to some analysts.
Kuroda said the higher long-term interest rates are due partly to growing confidence in Japan's economy, but the volatility seen since the BOJ overhauled policy last month shows how difficult it will be for the central bank to control long-term yields.
"It seems like Kuroda is essentially leaving the market as it is," said Ayako Sera, senior market economist at Sumitomo Mitsui Trust Bank.
The recent surge in the 10-year JGB yield to a one-year high of 0.92 percent "does not seem to count as a leap in long-term bond yields for Kuroda," she said.
"We still need to be wary of further rise in JGBs volatility."
Last week, in the midst of the market turbulence, the BOJ sought to cap the spike in yields by offering to inject 2.8 trillion yen into the Tokyo money market, more than three times the size usually offered in a single day.
Kuroda indicated that the BOJ could use this tool in the future by offering funds for one year at a fixed rate to ease market jitters.
After he spoke, the central bank said it will meet with JGB-market participants on May 29 to discuss recent market moves and operations. The BOJ will use this meeting to help it decide its schedule for JGB purchases from June, a BOJ official said.
Bond prices turned negative after the BOJ announcement on disappointment that the bank didn't address the market turbulence. Cash-bond prices later ended the day flat, with the 10-year yield at 0.880 percent, not far from last week's high. Futures prices dipped slightly in evening trade on Kuroda's remarks.
The BOJ unleashed the world's most intense burst of stimulus last month, promising to inject $1.4 trillion into the economy in less than two years to meet its pledge of achieving 2 percent inflation in roughly two years.
Doubts have emerged over whether that time frame is realistic.
In the BOJ meeting, board member Takahide Kiuchi proposed loosening the commitment by making its inflation target a medium- to long-term goal, and committing to intensive easing in the next two years. His proposal was rejected in an 8-1 vote.
Indeed, the BOJ may be stuck pursuing its massive monetary easing for up to five years before it stokes enough inflation to start unwinding its aggressive stimulus, a Reuters poll of BOJ watchers suggested on Wednesday.
The prospect of a long wait before the BOJ can begin tightening stands in stark contrast to expectations in global markets that the U.S. Federal Reserve could taper off its huge bond-buying campaign as early as this year.
The BOJ, by gobbling up JGBs, hopes to nudge Japanese investors out of the safety of bonds and into riskier assets like equities, encouraging more consumption, investment and employment in a virtuous circle to revitalize growth.
But it is proving difficult to engineer a gentle rise in yields.
BOJ officials say they would accept a natural rise in long-term interest rates that reflect prospects of an economic recovery and future inflation.
Japan's economy expanded at an annualized 3.5 percent in the first quarter, the fastest in a year, offering more evidence that Abe's sweeping stimulus is beginning to work.
But the gains remain tentative. Abenomics got a reality check on Wednesday as April exports grew less than expected and imports surged on expensive energy imports, blowing out the trade deficit to the biggest April gap ever.
A sustained sharp rise in bond yields would hurt corporate capital spending, the soft spot of an otherwise more robust economy, and strain Japan's already tattered finances by boosting the cost of funding its huge debt pile. ($1 = 102.9750 Japanese yen)