Bank of Japan: A hard-fought compromise

TOKYO: The Bank of Japan appears to have accomplished a tactical masterstroke in giving Prime Minister Shinzo Abe an ambitious inflation target and an “open ended” commitment to buying assets, without expending any of its policy firepower.
At least that is financial markets’ initial read. Japan’s central bankers see it differently; a hard-fought compromise that allowed the Bank of Japan to fend off the most serious threat to its 15-year independence, but which left it obliged to carry out more radical policies in the future.
“For the BOJ, once the law is revised it’s game over,” said a source familiar with policymaker thinking. The source spoke on condition of anonymity due to the sensitivity of discussing central bank issues.
Markets were less than impressed with the BOJ measures. The yen, which fell steadily in the buildup to the meeting on expectations of bold action, has risen. Tokyo’s Nikkei average, which rose in the hope a weaker yen would boost exports, fell on Wednesday to a three-week closing low.
The disappointment is based on the fact that the BOJ’s open-ended asset purchases will only begin next year and will expand the central bank’s balance sheet by a relatively modest 10 trillion yen ($ 114 billion). The BOJ topped up its existing asset buying program by 46 trillion yen in 2012 alone.
It will not boost asset purchases this year beyond its existing program and refrained from taking on longer-dated bonds or risky assets, a sign it remains cautious, not bold.
Abe lauded the BOJ decision as “epoch making” and the government’s top spokesman said he now saw less need to revise the BOJ Law guaranteeing its independence, given the central bank’s commitment to a new price target. That suggested the BOJ had bought some time.
“They’ve been very smart, getting the government not to change the BOJ law without doing anything that dramatically different,” said Neale Vincent, strategist at Nomura Securities in Tokyo.
As time goes by a different picture could emerge. By committing in a joint statement with the government to double its inflation target to 2 percent, the BOJ gave politicians a pressure button that could be pressed at any time given doubts the country can achieve such an inflation level anytime soon.
It has experienced 2 percent inflation in only a handful of months since the late 1990s.
The next trigger point is likely to be the appointment of a successor to BOJ Governor Masaaki Shirakawa in two months time, analysts say. Abe has made no secret of the fact he wants a governor in office more sympathetic to his views and once in place Abe could press his advantage.
The government will also review progress in achieving the inflation target on a quarterly basis at its top economic panel.
At the next such review in April, it is almost certain the target will not have been met. Both headline consumer prices, or the more closely watched core consumer index that excludes volatile fresh food prices, have struggled to rise beyond 0.5 percent at any point in several years.
“Abe seems to be quite happy with the new inflation target, so I don’t think he will pressure the BOJ into acting again next month. But there could be one more easing by April,” said Izuru Kato, chief economist at Totan Research Institute in Tokyo.
“Much will depend on the economic outlook and the future direction of the yen,” he said.
When bolder action from the BOJ is needed, the new open-ended approach gives the central bank more flexibility. It can increase monthly purchases if it needs to roll over huge amounts of treasury discount bills.
If it wants to expand its balance sheet, it can extend the maturity of government bonds it accepts to five years from the current three years, the sources say.
There is not much to stop the board from boosting the volume of monthly asset purchases, shifting to longer-dated bonds or bringing forward its launch — all of which would make it into a much more potent stimulus.
To be sure, the central bank managed to push back on several fronts in its policy battle with the government. It avoided setting a deadline for achieving the inflation target and avoided adding job growth to its mandate, which it sees as problematic because of the government’s role in influencing both factors.
The statement also included a caveat that meeting the inflation target depended on government efforts to lift the economy’s long-run growth potential, and obliged the government to provide assurances that it will respect fiscal discipline.
“The BOJ threw the ball back in the government’s court,” said Daisuke Karakama, market economist for Mizuho Corporate Bank in Tokyo.
Although further government pressure on the BOJ is likely in the months ahead, the central bankers may find allies in unlikely places. Some politicians are growing wary of pushing the BOJ too hard, fearing that threats to its independence could scare investors into selling bonds en masse, an unappetizing prospect for a country with the biggest debt burden among industrialized nations.
Japan’s aggressive push for monetary stimulus and resulting yen decline have also sent ripples abroad, which may temper how hard Abe’s government pushes the BOJ.
Both International Monetary Fund chief Christine Lagarde and Bundesbank chief Jens Weidmann have voiced concerns about threats to the BOJ’s independence. Russia and Germany have warned Tokyo is contributing to a global liquidity glut that risks competitive currency devaluations.
“Japan cannot afford a diplomatic row over currency. It’s mindful of the risk of going too far,” said another source familiar with policymakers’ thinking.