(Adds details, background, context on policy)
* BOJ increasingly wary about cost of flat yield curve
* BOJ may use combination of tools, forward guidance
* No board consensus yet on best policy step
* More radical steps not off table at Sept 21 review
By Leika Kihara
TOKYO, Sept 9 (Reuters) - The Bank of Japan is studying several options to steepen the bond yield curve, say sources familiar with its thinking, as authorities desperately seek out policy tools to revive an economy that has failed to emerge from stagnation despite years of massive stimulus.
BOJ officials have become increasingly wary of the costs of a flattening yield curve, such as hurting bank profits, especially as its controversial decision to adopt negative rates in January has made matters worse.
Bank bureaucrats are brain-storming ways to cut short- to medium-term bond yields, which affect corporate borrowing costs the most, while pushing up super-long yields from undesirably low levels, the sources said on condition of anonymity.
The options might be debated at this month’s rate review as part of measures to fine-tune its massive stimulus programme, they said.
The challenge for the BOJ would be to come up with ways to lift long-term yields, without giving markets the impression it is withdrawing stimulus.
Among ideas being floated is to make the BOJ’s bond buying more flexible and offering markets clearer guidance on the future path of policy, the sources said.
“With negative rates now added to the policy framework, the BOJ can combine its tools in numerous variations,” said one of the sources familiar with its thinking. “Offering forward guidance could also be very effective.”
More radical ideas, such as switching its policy target to interest rates from base money, remain on the table. But there is no consensus within the nine-member board yet on what the most appropriate step would be.
FORWARD GUIDANCE AN OPTION
Japan’s yield curve flattened markedly after the BOJ adopted negative rates, surprising policymakers who did not expect super-long yields to fall so much in response to a step aimed at reducing short-term rates.
Many analysts expect the BOJ to ease at its Sept. 20-21 rate review, when it conducts a comprehensive assessment of its policies that will examine why three years of heavy money printing has failed to accelerate inflation to its target.
The assessment will also look at ways to mitigate the rising costs of its stimulus programme that combines negative rates with a huge asset-buying programme.
A flat yield curve benefits companies borrowing money for long-term investment. But it hurts bank profits and household sentiment by making pension investment difficult - costs Governor Haruhiko Kuroda recently acknowledged.
“One thing we could consider as a policy option is ways to change the shape of the yield curve,” BOJ board member Makoto Sakurai told Reuters, a view shared by at least two other members of the board.
Several ideas to fix this are being discussed internally.
One is to slow the pace of long-term bond purchases but offset the monetary tightening effect by deepening negative rates, the sources said. This would allow the BOJ to argue that taken together, it is loosening policy.
But with January’s negative rate decision having proved deeply unpopular among the public, opponents of this idea worry that deepening negative rates now could be counter-productive.
Another idea is for the BOJ to set a timeframe for how long it will keep buying government bonds at the current pace, and leave open the possibility of tapering purchases after that.
By offering such guidance, the BOJ could lower yields for up to 10-years while lifting the long end of the curve by spurring market expectations of future tapering, the sources said.
What options will be chosen depends largely on how the board members weigh the pros and cons of each step, they said.
Many BOJ officials dismiss the idea of buying foreign bonds, arguing that doing so to weaken the yen would infringe on the finance ministry’s jurisdiction over currency intervention.
The BOJ could technically buy foreign bonds from domestic financial institutions and describe the step as aimed at supplying yen liquidity, not weakening the yen. But the amount of foreign bonds held by domestic banks is probably too small to have a sizable impact on the economy, the sources said.
“It would be hard to justify buying foreign bonds when there are many domestic assets still available for the BOJ to buy,” said one of the sources. (Additional reporting by Yoshifumi Takemoto and Sumio Ito; Editing by Shri Navaratnam)