By Max Sato
(MaceNews) – The Bank of Japan is committed to maintaining its current monetary easing framework aimed at guiding low inflation toward its 2% target despite the recent rapid depreciation of the yen, which could further push up import costs amid rising food and energy costs.
The BOJ on Monday resumed unlimited fixed-rate operations to buy 10-year Japanese government bonds at a yield of 0.25%, the upper limit of its guidance range, and announced that it is conducting such operations from Tuesday until Thursday. Previously, the bank used this type of market operation on Feb. 14 to defend the 0.25% line, its first since July 2018.
“With regard to the outright purchases of JGBs (competitive auction method) during the period indicated above, the bank may add more dates and increase the amounts of purchases as needed, taking account of market condition,” the BOJ said in a statement, showing its determination to defend the upper end of its range of minus 0.25% to plus 0.25% for the yield on 10-year JGB.
The latest action fueled dollar buying for yen as market participants were convinced that the BOJ would maintain its easing stance while the Federal Reserve is set to raise interest rates aggressively. The dollar surged to around Y125, a level unseen since August 2015.
The BOJ has no authority or effective tools to have a direct and sustained impact on foreign exchange rates. The Ministry of Finance, which formulates currency market intervention policy in close contact with its US counterpart, has not shown any signs of stepping in to stop the dollar from rising further.
BOJ policymakers have made it clear that the bank would not scale back its easing or switch to tightening just because other major central banks have to do so to fight decades-high inflation. Japan’s inflation rate is under 1% and unlikely to be anchored around 2% any time soon even if high energy and commodities markets temporarily push up the annual rate to about 2% this year.
Governor Haruhiko Kuroda told a news conference on March 18 after the bank’s two-day policy meeting that it is natural for the US and European central banks to reduce the degree of easing or raise interest rates, which he said should support sustainable economic growth.
Kuroda: No Need for BOJ Policy Shift
“That does not mean that Japan needs to raise interest rates, and I don’t think a widening of interest rate differentials will immediately cause the yen to depreciate under these circumstances,” he said.
Kuroda added that research has shown that there is no clear relationship between exchange rates and interest rate gaps among different countries.
The governor has acknowledged that the central bank must watch for downside risks of sharp gains in energy and commodities prices lowering real household incomes and corporate profit margins, but he is sticking to his view that “there is no change to the basic structure that the depreciation of the yen is positive for our economy by pushing up both economic growth and prices.”
The recent spike in import costs amid rising global energy, food, and materials prices is regarded as “cost-push” inflation and thus “not favorable” as it deteriorates Japan’s terms of trade, but “the depreciation of the yen is playing only a limited role and it (inflation) is basically caused by the rise in dollar-denominated prices in international commodities markets,” Kuroda told reporters.
Stuck with Politically Set 2% Target
The BOJ is stuck with a politically motivated 2% inflation target adopted in January 2013. Nationalist blueblood politician Shinzo Abe used slogans such as “correct the strong yen” and “regain Japan” to bring the Liberal Democratic Party back to power in a landslide win in December 2012 lower house elections.
As Abe took office as prime minister, he pursued his campaign promise to defeat years of deflation with large-scale monetary easing, flexible fiscal spending and deregulation. Kuroda, a former senior MOF official, agreed with Abe’s reflationary policy mix, cut short his tenure as president of the Asian Development Bank and returned to Tokyo to take the helm at the BOJ.
Until Masaaki Shirakawa, Kuroda’s predecessor, accepted Abe’s demand to set a clear 2% inflation target in early 2013 (effectively in exchange for the central bank’s independence of political influences), BOJ officials had been reluctant to set a 2% target, which was considered a norm among some central banks but appeared too high for Japan.
When Kuroda launched plans in April that year to inject massive amounts of cash in the financial system and keep borrowing costs at super-low levels, he believed the BOJ could turn around the deflationary mindset among firms and households. He even declared that the bank would achieve the 2% inflation target “at the earliest possible time, with a time horizon of about two years.”
But the deflationary mindset turned out to be much more stubborn than expected and a 70% drop in crude oil prices from mid-2014 to early 2016 pushed Japan’s inflation back to near zero from around 1.5%, excluding the direct impact of the sales tax hike from 5% to 8% in April 2014, which dealt a long-lasting blow to consumption. The government raised the tax rate further to 10% in September 2019 and companies have been cautious about raising retail prices for fear of dampening sentiment further.
Kuroda’s persistence that the net impact of the weak yen is positive for Japan reflects concerns among BOJ officials that any remarks suggesting that the current yen fall is overdone could trigger an unwanted dollar slip in the longer term back below Y100. While a weak yen pushes up exporters’ repatriated dollar income, a strong yen lowers their profits and thus hurts sentiment in the Japanese stock markets.
Stuck with Yield Curve Control
The BOJ is also stuck with easing under the yield curve control framework as it is inextricably linked to guiding inflation above 2% first (overshoot commitment) and then anchoring it around that level.
The bank is unlikely to hit the target before Kuroda’s second five-year term ends in April 2023. That means unless the BOJ and government want to change their 2013 policy agreement including the 2% target, the BOJ is bound by its goal to keep its easing stance after Kuroda retires.
The BOJ has maintained its monetary easing stance under the yield curve control framework it adopted in September 2016, vowing to keep zero to negative interest rates “as long as necessary” to achieve its 2% inflation target in a stable manner.
Under the framework, the BOJ is keeping the 10-year government bond yield, the benchmark for long-term borrowing costs, at around zero percent by buying “a necessary amount” of Japanese government bonds “without setting an upper limit,” and to keep the overnight interest rate at -0.1% by charging 0.1% interest on a part of cash reserves parked at the bank by financial institutions.
In March 2021, the BOJ board decided to add new tools and tweaked existing schemes to make its monetary easing response “more flexible and nimble” in its prolonged battle to guide inflation toward its 2% target from around zero.
Among key items in its policy review, the BOJ made it clear that it was now allowing the 10-year yield on JGBs to fluctuate 25 basis points (0.25 percentage point) either side of the target level, which is currently around zero percent.
Not Much Japan Can Do To Stop Yen Fall
There is not much BOJ or government officials can do to stop the yen’s fall, except to “keep a close watch.” The MOF could consider asking the US Treasury to step in the FX market together to sell dollars for yen but the US probably wants to keep a fairly strong dollar to cap its own import costs.
For now, Japanese officials are expected to repeat their usual phrases that “rapid movements in the currency market are not desirable” and “foreign exchange rates should reflect economic fundamentals.”
Market participants regard Y125 to the dollar as a key level. In the previous weak yen phase, Kuroda said in his parliamentary testimony on June 10, 2015 that the yen was unlikely to continue depreciating from the existing level, triggering the dollar to slip below Y123 after rising above Y125. “A rate hike by the U.S. Federal Reserve Board may not necessarily cause the dollar to appreciate and the yen to depreciate,” he told the Lower House Financial Affairs Committee at the time. “The dollar does not have to rise further.”
Japanese officials may also stay cautious about seeking a joint forex intervention.
History also shows that when the dollar’s upward momentum is high, dollar-selling market intervention alone may not be so effective. It took some time before rounds of dollar-selling operations had any effect on the exchange rate in the 1990s.
Japan has not intervened in the forex market after having spent Y9.09 trillion on selling yen for the U.S. currency in the final quarter of 2011. And that was to stop the yen from rising, not the dollar.
MOF data showed that Japan intervened in the foreign exchange market on Oct. 31, 2011, when the yen hit a fresh life-time high of Y75.32 versus the dollar, and conducted further yen-selling operations from Nov. 1 to Nov. 4.
In 2011, Tokyo also conducted currency market intervention in March and August with the former operation forming part of a coordinated move by the Group of Seven industrialized nations to aid Japan in the wake of the March 11 earthquake disaster. It was the first concerted G7 forex action since September 2000, when the euro came under heavy selling pressure as capital flowed into the U.S. stock market at the peak of the IT bubble.