March 9, 2016 / 9:27 AM / 2 years ago

Japan central bank to hold off rate cut amid unstable bond market: sources

TOKYO (Reuters) - The Bank of Japan is set to hold off cutting interest rates at next week’s rate review, sources say, as it scrambles to soothe market jitters caused by January’s surprise decision to adopt negative interest rates.

Markets are rife with speculation the BOJ will expand monetary stimulus in coming months to reflate a stagnant economy, after January’s move failed to boost stock prices or arrest an unwelcome rise in the yen.

But many central bank policymakers are reluctant to ease again soon unless external shocks jolt global financial markets enough to derail Japan’s fragile economic recovery.

Even if it were to act, the BOJ would prefer to top up asset purchases rather than cut rates, say sources familiar with the bank’s thinking, given the bond market instability and public criticism January’s negative rate decision received.

“Now is the time to carefully scrutinize how the effect (of the negative rate policy) will spread to the economy,” BOJ Governor Haruhiko Kuroda said on Monday, signaling that no immediate stimulus was forthcoming.

While the intention of negative rates was to push down already-low borrowing costs, some BOJ officials worry that the recent sharp drop in long-term bond yields may be overdone and driven largely by speculative trading.

“Negative rates have proved very powerful in pushing down bond yields,” said one source. “The BOJ doesn’t intend to keep cutting rates frequently at a set timing.”

Cutting rates again may also draw criticism from banks, many of whom are angry for having their already thin margins squeezed and being caught offguard by the BOJ’s sudden decision.

The BOJ stunned markets late January by deciding to cut rates into negative territory, adding to its massive asset-buying program dubbed “quantitative and qualitative easing” (QQE) in a fresh drive to accelerate inflation to its 2 percent target.

Japanese government bond yields tumbled to fresh record lows on Tuesday after a firm 30-year auction fueled a rally for debt instruments that still offer positive yields.

At the two-day policy meeting ending on Tuesday, the BOJ’s nine-member board will examine whether overseas headwinds and slow wage growth have hurt exports and consumption enough to derail a fragile economic recovery.

Japan’s economy contracted in the final quarter of 2015 and some analysts expect it to slide back into recession in the current quarter, as slow wage growth and sluggish global demand weigh on consumption and exports.

Given the gloomy outlook, many analysts polled by Reuters expect the BOJ to ease again at or before the July policy meeting.

But with markets unstable from the January move and banks struggling to adapt their trading systems to negative rates, the BOJ has little to gain by easing again soon, some analysts say.

($1 = 112.5600 yen)

Additional reporting by Sumio Ito and Yoshifumi Takemoto; Editing by Sam Holmes

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