Less QQE, more YCC? With new framework, BOJ braces for long-term battle

TOKYO (Reuters) - Running out of tools to battle external headwinds, the Bank of Japan has opted to set a yield curve control - an idea it has long discussed internally as a future option, but which was considered controversial and technically challenging.

Bank of Japan (BOJ) Governor Haruhiko Kuroda attends a news conference at the BOJ headquarters in Tokyo, Japan, September 21, 2016. REUTERS/Toru Hanai

The decision announced on Wednesday was a compromise to ensure there was something for everyone in a fragmented nine-member board - except for two outliers deemed impossible to convince - said people familiar with the BOJ’s thinking.

It also suggested that Governor Haruhiko Kuroda no longer had the ammunition to deploy another “bazooka” stimulus and so was shifting the policy framework from shock therapy to one better suited for a long battle against deflation, they said.

“This is clearly a change to prepare for a long-term battle to hit the price target,” one source said on condition of anonymity. “It’s a modification to make the BOJ’s policy framework more sustainable.”

The main purpose of the policy overhaul was to abandon the base money target - a symbol of Kuroda’s signature “quantitative and qualitative easing” (QQE) program - in a face-saving way that does not give markets the impression it was withdrawing stimulus.

The target, under which the BOJ pledged to print money at an annual pace of 80 trillion yen, was forcing it to gobble up bonds at an unsustainable pace even as it failed to accelerate inflation to a 2 percent target.

“The idea of conducting a comprehensive assessment was really about ditching the base money target,” said another source. “It’s tricky, but do-able.”

Abandoning the base money target would make the BOJ’s bond buying more flexible and open up new options, including setting a long-term interest rate target.

Setting a yield curve target has been among the preferred options for BOJ bureaucrats drafting monetary policy. Supporters say it’s an easier step than forcefully crushing yields by buying huge amounts of bonds.

The challenge was to decide which zone of the curve to target, and explain what the desirable yield curve would look like.

After much debate, the bank opted to target 10-year bond yields because of its domestic benchmark status. Instead of setting an explicit cap across the curve, the BOJ would push down short- to medium-term borrowing costs while allowing for a natural rise in super-long yields.

That would address some concerns held by BOJ officials, and shared by Prime Minister Shinzo Abe’s administration, over what they saw as an excessive flattening of the bond yield curve that could squeeze financial institutions’ already thin margins.

“The BOJ was gradually shifting its focus on the interest rate element of its stimulus,” said a third source. “Among the options, topping up bond buying was now the lowest on the list.”


Kuroda initially preached the benefits of expanding base money, but gradually backed away and sided with those wanting to overhaul the huge asset-buying program.

A former top currency diplomat, Kuroda’s priority was to halt unwelcome yen gains that would hurt Japan’s export reliant economy, sources say. With the BOJ’s bond buying reaching its limits, guiding yields lower through direct rate targets appeared a more preferable approach.

Policymakers who work for Kuroda say he is a pragmatist open to new ideas and willing to be flexible on policy. “If he sees benefits in changing things, he’ll do so without hesitation,” said one official. “He doesn’t like making excuses.”

In a speech two weeks ago, Kuroda emphasized how the BOJ’s policies were pushing down real interest rates. He did not mention the base money target.

In a departure from his earlier approach, he told reporters on Wednesday: “In the short-term, there isn’t a clear link between the base money target and inflation expectations.”

The challenge was to convince Deputy Governor Kikuo Iwata, a former academic who introduced the idea of setting the base money target, and has insisted that expanding base money was effective in heightening inflation expectations.

Two more board members favored focusing on the effect of expanding base money in pushing up prices and spurring public expectations that inflation will accelerate. But those backing heavy money printing didn’t insist on keeping the base money target, as long as the BOJ kept up the pace of printing money and buying assets, the sources said.

In a likely compromise, the BOJ pledged to keep buying bonds at the current pace even after abandoning the target, and leave base money expansion among future easing options.

Kuroda could count on the support of Hiroshi Nakaso, the other deputy governor, and two other swing voters appeared to have no strong views on ditching the base money target, as long as the bank’s ultra-easy policy was in place.

Former market economists Takehiro Sato and Takahide Kiuchi, consistent dissenters to recent easing proposals, were sidelined from the start. As expected, they voted against the shift, warning it would hurt financial intermediation.

While Kuroda sought to dispel market concerns he was running out of policy ammunition, he acknowledged the BOJ was buying bonds in huge amounts, and could slow the pace of purchases.

“With the new framework, the BOJ probably won’t use its easing tools so frequently,” said a source. “It will probably use it only in the event of a severe yen spike.”

Reporting by Leika Kihara; Editing by Ian Geoghegan