TOKYO (Reuters) - The Bank of Japan may allow long-term interest rates to creep up to around 0.4 percent under new guidance introduced last month, which lays the groundwork for “stealth” rate hikes, the central bank’s former executive Hideo Hayakawa said on Thursday.
The BOJ kept its yield targets steady last month but said it will allow long-term rates to move more flexibly around its zero percent target, a nod to criticism its heavy buying was shrinking bond market liquidity.
BOJ Governor Haruhiko Kuroda said long-term rates would now be allowed to move at double the range previously permitted. While market players interpreted the remark as a sign the BOJ will tolerate a rise in 10-year bond yields to around 0.2 percent, they remain unsure over how much yields would be allowed to rise beyond that.
Hayakawa said the BOJ likely does not see 0.2 percent as its new line-in-the-sand, and may tolerate yield rises to around 0.4 percent without explicitly hiking its yield target.
“With the changes made in July, the BOJ can now conduct ‘stealth’ rate hikes,” or allow long-term rates to rise without explicitly hiking its yield target, Hayakawa told Reuters.
“It’s probably difficult to allow long-term rates to rise above 0.5 percent. But the BOJ could tolerate a rise to 0.2 percent, 0.3 percent and then 0.4 percent,” said Hayakawa, a former top BOJ economist who retains close contact with incumbent policymakers.
The BOJ, however, will step in to cap yields if their rises narrow the interest rate differential with the United States and trigger an unwelcome yen rise, he said.
“The BOJ itself probably doesn’t have a clear idea on how far it will allow yields to rise. It will play it by ear, taking one step at a time,” said Hayakawa, now a senior economist at private think tank Fujitsu Research Institute.
Uncertainty on the BOJ’s new guidance has kept the benchmark 10-year bond yield around 0.1 percent. It stood at 0.095 percent on Thursday.
The new guidance on yield moves was part of measures the BOJ took last month to make its policy framework more sustainable, as subdued inflation forces the bank to maintain its ultra-easy policy despite some of the negative impacts of prolonged easing on the financial system.
The central bank’s latest quarterly projections showed inflation will miss its 2 percent target at least until the year ending in March 2021.
Hayakawa said there was a good chance Japan’s economy, on course to mark its longest postwar expansion, will slip into recession either in 2019 or 2020, as next year’s scheduled sales tax hike cools consumption and construction demand related to the 2020 Tokyo Olympic Games peters out.
“That means the BOJ will have virtually no ammunition to fight the next recession,” Hayakawa said. The government cannot boost fiscal spending given Japan’s huge public debt, he added.
The next recession could also destabilize Japan’s banking system as rising corporate bankruptcies would increase credit costs for financial institutions, already seeing their profits eroded by years of near-zero rates, said Hayakawa.
“July’s moves by the BOJ were clever but half-hearted in addressing the risks emerging from prolonged easing,” he said.
“There are limits to what the BOJ can do, without a more thorough debate and analysis of the demerits of its policy.”
Additional reporting by Sumio Ito; Editing by Sam Holmes