By Leika Kihara
TOKYO, April 5 It was a secret Valentine's Day mission involving
only half a dozen Bank of Japan bureaucrats who worked through the weekend
preparing for the central bank's Feb. 13-14 meeting.
The governor had just been publicly heckled by politicians over seemingly
endless deflation and a yen near record highs. Bold steps were needed to restore
the BOJ's standing, and quickly.
"Until February, the BOJ's message was that mild deflation was inevitable,
and that it didn't need to act as long as the economy was doing fine," said a
source familiar with the central bank's thinking. "That perception had to
The inner core working that weekend at the BOJ knew surprise would be the
key to success, and so abstained from the usual practice of leaking plans to the
media to massage expectations.
It worked a treat. Unsuspecting markets were stunned by the BOJ's two-punch
combination of adopting a 1 percent inflation target and a hefty increase in its
The yen was knocked down just as effectively as if the BOJ had bought
hundreds of billions of dollars in currency intervention, and over the next
month fell to an 11-month low.
Perhaps more importantly, the Valentine's Day surprise marked a fundamental
change in the way the central bank sees its mission, how it will carry it out
and sell it to the public.
The central bankers had been aware for some time of two problems. First,
with interest rates already near zero and the economy mired in deflation, their
conventional tools were not working. Second, the BOJ had an image problem,
perceived as an institution always doing too little too late.
So the BOJ very deliberately sent investors and politicians the signal they
have been waiting for -- that it was ready to deploy unconventional weaponry to
lead Japan out of deflation.
"When you set a goal, you have to show that you're serious about achieving
it. You have to match words with action," said a senior official at the central
The remaking of the central bank is only beginning. Over the next year there
will be new board members and possibly a new governor - a chance to shape
thinking on how to reinvigorate the world's third-largest economy.
The challenge for all will be how to reconcile calls for vigorous action to
take Japan to its inflation goal - a level it has not seen for nearly two
decades save for a few blips - and concerns it could be seen as bankrolling vast
The plan to shake up monetary policy started to take shape in December,
sources close the central bank said.
There was push to act in January when the yen was near record highs and the
risk of a disorderly Greek default loomed large, and most on the nine-member
policy board were leaning toward action.
But it would take another month to convince Governor Masaaki Shirakawa, who
remains sceptical of what can be achieved by pumping cheap money into an economy
beset by structural problems like an ageing population and shrinking work force.
Those who have worked with him say he is particularly uncomfortable doing
something just for psychological effect, and in his view that includes feeding
more cash to banks that have trouble absorbing the funds already available to
Central banks normally worry about containing inflation, but Japan has been
faced with persistent falls in prices. Deflation weakens the economy because it
encourages consumers and businesses to hold off on spending because prices will
fall, and companies struggle to pass on higher costs of fuel and commodity
Insiders say hostile grilling of Shirakawa in parliamentary hearings the
week before the February meeting may have persuaded the soft-spoken career
central banker to move.
Lawmakers demanded the BOJ set a clear inflation goal the way the Federal
Reserve had, repeatedly heckling the 62-year-old banker. At one point the jeers
got so loud that they drowned Shirakawa's voice, and it was all broadcast live
"People who watched that scene would have thought the BOJ wasn't doing
anything to cure Japan's ills. That image had to be changed," said a source with
knowledge of the BOJ's thinking.
Tired of being a whipping boy for politicians who have long shied away from
fiscal reform, central bankers decided to wrest back the initiative and also
show some support to Prime Minister Yoshihiko Noda, who they view as best placed
to put Japan's tattered finances back in order.
With public debt at twice the size of the $5 trillion economy, Noda's plan
to double the sales tax to 10 percent is under attack from those who say the
economy is still too weak.
With even members of his own party opposed to the plan, Noda needs all the
help he can get and sources say the central bank is ready to provide that to
The sources say that in contrast to past spells of tense relations between
government and central bank chiefs, Noda and Shirakawa get along well and meet
about once every three months casually, sometimes over breakfast or lunch.
"There is now trust and a good working relationship between the two sides,"
said a source with knowledge of the meetings.
But while relations between the finance ministry and central bank have been
less fraught since February, bureaucrats at the ministry are still seeking
further stimulus from the BOJ to keep the economy strong enough to weather any
future sales tax hike, say officials with direct knowledge of the negotiations.
CHANGING OF THE GUARD
With Shirakawa at the helm, there will be tension between those in the BOJ
keen to sustain the psychological effect of the central bank's new image of a
bold deflation fighter, and his supporters who are wary of using heavy monetary
artillery too often.
"He doesn't like 'big bang' steps. It's not his style," said a former BOJ
board member who worked with Shirakawa.
Indeed, the central bank has found itself playing down the impact of its
February move to temper expectations of further bombshell steps.
The board meets again next week, although markets expect that any follow-up
action to the February meeting will be delayed until a late April meeting that
includes a review of macroeconomic forecasts.
Many who have worked with Shirakawa say the hard-working perfectionist is
cautious by nature and has a stubborn streak, although the February moves show
he is not an obstructionist.
His term as governor ends in April 2013. Theoretically Shirakawa could be
reappointed, but the government is likely to look for someone willing to step
outside the boundaries of traditional central banking.
Toshiro Muto, a former finance ministry bureaucrat and deputy BOJ governor
who is considered a leading candidate to succeed Shirakawa, says the central
bank is already pursuing quantitative easing, where the stimulus is measured by
liquidity released into the financial system rather than the level of official
rates, even if it is not explicitly using the term.
One step Shirakawa has been reluctant to make and which Muto said could be
necessary was to buy more longer-dated government bonds to prolong the
"Whatever it does might have to be small steps. But the BOJ's next challenge
is to come up with ways to further pursue its quantitative easing policy," Muto
told Reuters in an interview on March 30.
BREAKING THE RULES
Shaping Shirakawa's caution is his experience in 2001-2006 as one of the
elite BOJ bureaucrats who masterminded the central bank's previous spell of
quantitative easing, where it targeted cash balances of commercial banks.
Shirakawa believes the cash was not funnelled to productive sectors so did
not prevent Japan from slipping into a decade of economic stagnation and
Having joined the BOJ in 1972, he has spent most of his career facing the
traditional problem of containing inflation as Japan's economy boomed and asset
price bubbles grew, whereas views of his younger cohorts have been shaped by
economic stagnation and deflation.
So while many BOJ bureaucrats agree that merely flooding the economy with
funds may not provide the spur to end deflation, they are also not as concerned
about the risk of asset price bubbles re-emerging or inflation getting out of
And they worry that years of brow-beating by politicians have eroded
confidence in their institution and baby steps are not enough to restore it.
"Markets got the impression the BOJ changed in February and that's
reasonable. It changed in the sense it is starting to violate a rule it made for
itself," said Teizo Taya, a former board member who left the BOJ in 2004 and is
now a professor of economics at Tokyo's Rikkyo University.
A test for the new mindset will be what the BOJ does on quantitative easing
over coming months.
Under its asset buying scheme the BOJ only buys government bonds of up to
two years until maturity. But with two-year yields already at 0.1 percent, any
further increase in the scheme would have to target five-year bonds to be
That would blur the distinction between the asset-buying scheme, intended to
be a temporary stimulus, and another operation where it buys 21.6 trillion yen
($263 billion) in long-term bonds per year.
Buying more bonds would bring it closer to violating a self-imposed rule
that its government bond holdings should not exceed the value of banknotes in
Muto says the central bank should not worry about its rules too much if
circumstances call for action.
"If the BOJ, out of necessity to prevent a plunge in bond prices, needs to
buy bonds beyond what's accepted under the banknote rule for a certain period,
it should do so," he said.
"The February action turned out as a surprise. The BOJ did more than what
was expected. On the other hand, there is room to do more. The real test has
only just begun."