TOKYO (Reuters) - A well-connected former central bank executive said on Friday the Bank of Japan may allow long-term interest rates to rise more next year if continued strength in the economy pushes inflation to around 1 percent.
Hideo Hayakawa, a former top Bank of Japan economist who retains close contact with incumbent policymakers, said the central bank would not be able to cap long-term rates for long if they rose because of improving economic fundamentals.
But if rates were driven up by external, temporary factors such as a spike in U.S. yields, the BOJ would have little trouble capping bond yields, he told Reuters in an interview.
Hayakawa said “core-core” consumer inflation, which strips away the effect of volatile fresh food and oil costs, could accelerate to around 1 percent in the fiscal year ending March 2019 thanks to the strengthening economy.
“If so, there’s a chance the BOJ will adjust its long-term rate target sometime next year,” Hayakawa said.
“A central bank cannot indefinitely cap bond yields at levels inconsistent with economic fundamentals.”
Under its yield curve control (YCC) framework adopted last year, the BOJ pledges to keep short-term interest rates at minus 0.1 percent and the 10-year bond yield around zero percent.
Hayakawa, who was among the few experts who predicted the adoption of YCC, said the BOJ may either raise the 10-year yield target or allow long-term rates to rise further by targeting the shorter 5- or 8-year segment of the curve.
Any such step could come before inflation hits the BOJ’s 2 percent target and would not be tantamount to monetary tightening as the bank would still keep borrowing costs very low, he added.
Japan’s economy expanded at an annualized rate of 2.5 percent in the second quarter thanks to robust exports and a pick-up in consumption.
But core consumer prices, which exclude fresh food but include oil costs, rose just 0.5 percent in July from a year earlier, well below the BOJ’s 2 percent target.
Core-core consumer inflation has hovered around zero percent so far this year and rose 0.1 percent in July from the year earlier, underscoring companies’ reluctance to hike prices.
The BOJ cut its price forecasts in July and now expects inflation to hit 1.1 percent in the year ending in March 2018, still exceeding a 0.6 percent rise projected in a Reuters poll.
Hayakawa, well-versed in the BOJ’s drafting of price forecasts, said the bank was unlikely to reduce much its price projections at its next quarterly review in October given growing signs of strength in the economy.
But he warned that achieving the BOJ’s 2 percent target will take several more years, forcing the bank to delay dialing back stimulus and leaving it with few resources to fight another recession.
“YCC is a sustainable framework but doesn’t have the power to dramatically boost inflation,” said Hayakawa, now a senior economist at the Fujitsu Research Institute, a private think tank.
“If the BOJ fails to hit its price target during the current economic expansion, it’s left with a pretty bad situation.”
Reporting by Leika Kihara; Editing by Eric Meijer