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01/13/2022 • 15 minutes ago • 4 minutes read • Join the conversation
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TOKYO – Bank of Japan policymakers are discussing how soon they can telegraph a potential rate hike, which sources say could come before inflation hits the bank’s 2% target, encouraged by rampant price hikes and a more restrictive Federal Reserve.
While an actual rate hike is unlikely to be imminent and the BOJ is on track to maintain its policies, at least for the remainder of this year, financial markets may underestimate their willingness to phase out their once radical stimulus package.
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In particular, the BOJ’s carefully worded promises to keep monetary policy accommodative apply only to the steady pumping of cash into the markets – not to keeping interest rates at the current low level.
“The BOJ has never made a commitment to hold rates until inflation exceeds 2%,” said a source familiar with the BOJ’s mindset, a view confirmed by two other sources.
“In theory, that means that it can raise interest rates before inflation is sustained above target.”
After nine years of aggressive monetary easing, the BOJ seems to be finally getting what it wanted. Inflation is nearing its elusive target and is already changing the public perception that deflation will continue.
With the surge being driven by higher commodity prices rather than a hoped-for surge in domestic demand, the BOJ’s short-term priority is to avoid a temporary spike in inflation that fuels market speculation about early monetary tightening.
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Many BOJ officials don’t expect conditions to materialize to warrant a rate hike this year as there is uncertainty about whether consumption will pick up enough to allow companies to hike prices further.
That could mean an actual rate hike may not come before 2023 and under a new governor who will succeed incumbent Haruhiko Kuroda, whose term ends next April.
But the Fed’s steady rate hike plan, a weak yen and growing public discontent over the rising cost of living are spurring the BOJ to be bolder in devising a future exit plan, sources said.
“For the first time in a while, there are not only downside risks but also upside risks to the price outlook,” said a second source.
“The BOJ needs to be very careful about what other central banks are doing,” a third source said, pointing to an increasing number of foreign counterparts considering rate hikes.
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The central bank’s nine-member board of directors is split between those who see scope for a reduction in incentives and those who are cautious about taking steps that could be interpreted as monetary tightening, the sources said.
CONNECT THE LINE FOR THE EXITS
The BOJ has already stopped quantitative easing (QE) by steadily reducing asset purchases at https://tmsnrt.rs/33uLBWQ. The current pace of bond purchases is less than a fifth of the level it was in in 2016 when it shifted to a policy that targeted interest rates from the pace of money printing.
It is also slowing purchases of risky assets and will phase out a loan program in support of the coronavirus pandemic in March to reduce the cash supply to the economy.
The BOJ was able to taper without partially shocking the markets, as the moves came as stocks rebounded and the yen gave way as a trend.
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For the BOJ, the sequence would be to further reduce asset purchases and move towards optimizing their yield curve control (YCC) targets, which are set at -0.1% for short-term rates and around zero for 10-year bond yields.
The central bank is starting to drop signals that the days of eternal zero interest rates may be numbered by signaling increasing prospects for rising inflation.
Kuroda said last month that rising commodity costs could cause inflation to approach its 2% target, sending out his clearest signal yet that upward pressure on prices will increase.
This was followed by a comment from Deputy Governor Masayoshi Amamiya that inflationary pressures are mounting as more companies are able to pass the costs on to consumers.
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The next step could be to adjust the guidelines for future interest rates, based on the current commitment to keep them at “current or even low levels,” the sources said.
This can happen before inflation reaches 2% on a sustained basis.
The BOJ promises to increase the pace of money printing until inflation stably exceeds 2%. However, it has made no commitments as to how long it will keep its interest rate targets at current levels.
“It is clearly intentional,” said a fourth source on the language of counseling. “The central banks must allow themselves a certain amount of flexibility in adjusting interest rates.”
While there is no consensus within the BOJ, ideas include moving away from negative interest rates, widening the implied band below which 10-year yields can hover around their 0% target, or looking for shorter bond yields, they said Sources.
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There is uncertainty about how quickly the BOJ can actually hike rates, even as expectations rise that the Fed will hike three times this year from March onwards.
Years of aggressive monetary easing and government pushing have failed to convince companies to raise wages.
Political factors also tie the BOJ’s hands.
The government relies on the BoJ to secure Japan’s huge mountain of debt, which, with twice the size of its economy, is the largest of the industrialized nations. Even a small increase in the cost of borrowing could deal a devastating blow to Japan’s finances.
That could mean that the job of raising rates would be left to the next BOJ governor. Amamiya is considered to be one of the strong candidates to succeed Kuroda.
“If consumers are more accommodating to price hikes, it could allow the BOJ to discuss rate hikes,” a fifth source said. “But negotiations with the government will not be easy and will take time, given Japan’s enormous national debt.”
(Reporting by Leika Kihara; Editing by Kim Coghill)
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