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Lessons from past haunt BOJ as yield rise sparks talk of tightening

TOKYO (Reuters) - For the first time in a decade the Bank of Japan is prepared to contemplate the possibility of a future rate rise – a radical shift for an extremely dovish central bank that now finds itself boxed into a corner by surging global bond yields.

A Japanese flag flutters atop the Bank of Japan building in Tokyo, Japan, September 21, 2016. REUTERS/Toru Hanai/File Photo

But that doesn’t mean the BOJ is anywhere close to pulling the trigger.

Not only Governor Haruhiko Kuroda and one of his deputy governors Kikuo Iwata - widely regarded as the architects of the BOJ’s massive money-printing experiment, but many others on the nine-member board would need a significant change of heart.

And central bank officials haunted by their two failures since 2000 to exit zero rates would rather be late in tightening than be caught out, and criticised, again for taking the steam out of the economy.

“The last thing the BOJ wants is to be blamed for ruining a budding economic recovery and to be criticised yet again for doing too little to spur growth,” said a source familiar with the BOJ’s thinking.

Under a new policy adopted in September, the BOJ shifted its policy target to interest rates from the pace of money printing in the hope doing so would relieve it from maintaining its huge government bond-buying that many analysts see as unsustainable.

The BOJ believed it could achieve its new pledge of guiding 10-year bond yields around zero with less bond-buying. But containing yields have proven more difficult than expected, as Japanese government bond (JGB) yields rose in tandem with soaring global rates on bets the incoming U.S. administration led by Donald Trump will boost fiscal spending, growth and interest rates.

After holding policy steady on Tuesday, Kuroda shrugged off talk of a rate hike, saying maintaining the massive quantitative and qualitative easing (QQE) stimulus remained the priority while inflation was under 2 percent.

Sources have told Reuters that the BOJ is more open to discussing raising its 10-year bond yield target and could even contemplate doing it at some point in 2017. [nL4N1E932H]

But Kuroda was vague on whether it would be up for discussion before his five-year term ends in April 2018.

“There’s a possibility we will debate it, and there’s a possibility we will not,” he said.


Japan’s economy is recovering moderately as factory output and exports show signs of life on a pick-up in emerging market demand. But inflation remains stubbornly low with core consumer prices falling for eight straight months in October.

When the BOJ raised interest rates to 0.25 percent from zero in August 2000, markets were confused because there had been no advance guidance. Only eight months later the BOJ was forced to adopt quantitative easing to battle a domestic banking crisis.

Things were much smoother when the BOJ exited QE in March 2006 and raised rates to 0.25 percent from zero four months later, as it had flagged its intention to withdraw stimulus when inflation had stably topped zero.

Still, the BOJ was criticised for hiking prematurely after the economy lost momentum.

“The hurdles for raising the target are higher than what most people think, and the BOJ understands this well,” said one source, a view echoed by at least three other officials.

The sources said the BOJ will likely only take baby steps toward any withdrawal of stimulus. Even then, any increase in its 10-year government bond yield target would be telegraphed as a minor fine-tuning of ultra-easy policy.

Takehiro Sato and Takahide Kiuchi, the two BOJ board members who have consistently raised doubts on the feasibility of QQE and could have spearheaded the drive toward higher rates, will step down when their terms end in July next year.

If the BOJ were to move up its 10-year yield target, it would most likely be in response to rises in market long-term interest rates reflecting broad improvements in the economy.

Some BOJ officials say they could explain the rate hike as neutral to the economy because the real cost of borrowing, adjusted for inflation, would not rise if inflation and inflation expectations are heightening.

“The BOJ probably won’t raise the target easily. It would take an unexpected, sustained increase in Japanese yields or inflation expectations to justify such a move,” said Mari Iwashita, chief market economist at SMBC Friend Securities.

Reporting by Leika Kihara; Editing by Shri Navaratnam