Elusive target

The Bank of Japan appears to be subtlety changing its strategy. As Haruhiko Kuroda walks away from his “shock and awe” stimulus in favour of incremental policy shifts, he is edging ever closer to the approach of his predecessor at the Bank of Japan, a man he once derided for being too cautious.

An actual exit from stimulus does not appear imminent. But according to the newswires, central bank policymakers have begun brainstorming ways to raise bond yields from near-zero levels as a first step toward ending crisis-mode policy, sources familiar with the Bank’s thinking say.

Last month’s decision to drop a deadline for hitting its inflation target was the latest sign the central bank is scaling back Kuroda’s radical monetary experiment. The move is partially an acknowledgement of the pain prolonged easing is inflicting on banks’ profits. It also gives the Bank of Japan more flexibility on monetary policy, which could prove useful if the central bank wants to raise its yield target before inflation reaches its goal of 2%.

Policy normalisation will be gradual, with plenty of advance signals to avoid disrupting markets – unlike the “bazooka” stimulus Kuroda deployed five years ago, the sources say. Reading those signals might not be easy, however, as the central bank will likely keep them nuanced, partly to ensure it can back off if markets overreact. The signs could be as subtle as a modest upgrade in the Bank’s assessment of inflation expectations or stronger warnings on the risks of prolonged easing.

Kuroda, under orders from Prime Minister Shinzo Abe to lift Japan out of decades of deflation, deployed a huge stimulus programme in 2013, pledging to achieve his 2% inflation target in two years. The idea was a sharp contrast to the approach of his predecessor Masaaki Shirakawa, who was criticised for a drip-feed approach of increasing stimulus incrementally. But years of money printing have failed to lift inflation, and the days of bold, sweeping policy moves might be over.

Kuroda says he still aims to achieve 2% inflation as soon as possible. But he has become more open to debating an end to stimulus, saying the central bank would discuss conditions to do so if the inflation target seems achievable.

Some central bankers warned that the cost of easing is rising and the returns diminishing, a summary of debate at the April rate review showed. The discussion was a sign the central bank is preparing markets for a future withdrawal of stimulus.

Behind the change is a growing view among politicians and policymakers that staying the course could do more harm than good. Mindful of such concerns, the Bank of Japan is brainstorming ways to justify a modest increase in its yield target, so long-term rates could rise and give banks room to profit.

In March, it released an academic paper showing how damage to Japan’s banking system could undercut the effects of stimulus. A month later, the central bank warned of a rise in bank loans to low-profit businesses.

There may be a point where monetary easing could work to hamper achievement of the price target. Identifying such risks will be key to future Bank of Japan policy. But that is no easy task, especially for a central bank fixated for so long on an elusive inflation target.

Alan McQuaid (15/5/18)
Economist