By Leika Kihara
TOKYO (Reuters) – Japan's central bank chief faces a key test of his communication skills at next week's monetary policy meeting. He is expected to keep alive the prospect of an end to negative interest rates while tamping down excitement that such a move is imminent.
Less than a year after taking office, Bank of Japan Governor Kazuo Ueda has twice misled markets with his comments on the future of monetary policy, most recently last week when bond yields and the yen fell on expectations of a near-term interest rate turnaround skyrocketed.
It has been more than 16 years since Japan's last interest rate hike and financial markets have become hypersensitive to any hint of an end to ultra-loose monetary policy, making it difficult for the BOJ to signal changes without triggering destabilizing spikes in bond yields.
But as the economic case for an end to accommodative policies strengthens, the BOJ's priority now more than ever is to avoid market surprises, three sources familiar with its thinking say. That means Ueda – unlike his predecessor, who shocked markets with abrupt policy changes – will try to drop some hints in advance.
“There is no good in surprising the markets, especially if central banks are scaling back their stimulus measures,” one of the sources said, a view echoed by another source.
That underscores the importance of what Ueda will say at his news conference after the Bank of Japan's two-day meeting that ended Tuesday, where the board appears to be making no significant changes to its ultra-loose policies.
More than 80% of economists surveyed by Reuters in November expect the BOJ to end its negative interest rate policy next year, with half of them predicting April as the most likely time. Some see the possibility of political change in January.
Ueda faces a difficult balancing act. With inflation exceeding its 2% target for well over a year, the BOJ wants to keep market expectations of a near-term shift alive.
But the BOJ must also avoid any explicit language or insinuations that pin it down to a specific point in time, meaning some ambiguity remains in its messaging.
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The BOJ's current strategy is to emphasize the conditions for an exit but not to announce the expected timing in advance, the sources said.
The delicate challenge of non-binding communication means Ueda could make a series of ambiguous comments that could potentially be misinterpreted and cause unwanted market volatility, some analysts say.
A more transparent way of communicating would be to adjust or abandon a dovish policy forecast that promises to increase stimulus if needed, although many in the BOJ are ruling out that option due to uncertainty about the economic outlook, the sources said.
The BOJ's communications are also constrained by a mismatch between its dovish policy stance and hawkish forecasts that predict inflation will remain near its 2% target through early 2026.
Ueda blamed cost pressures for the inflation overshoot and stressed that policy normalization must wait for inflation to be driven more by domestic demand and stronger wage growth.
But the governor himself acknowledged it would be a tough sell, telling lawmakers last week it was “difficult to explain all of this in a convincing way.”
Missteps in messaging not only cause market volatility, but also undermine the effectiveness of central banks' communications, an essential part of the policy delivery process.
Naomi Muguruma, senior market economist at Mitsubishi UFJ Morgan Stanley Securities, wants to focus on how Ueda describes the progress the BOJ has made in examining the price outlook.
“The key is how hard the BOJ will try to hint at the possibility of a policy change in January,” she said. “In any case, markets are likely to remain volatile as there is a risk that Ueda’s comments will be taken out of context again.”
(Reporting by Leika Kihara. Editing by Sam Holmes)
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