MNI INSIGHT: BOJ Could Link ETF Buying Pace To Risk Estimate

--Review of ETF Purchases May Come After April 2018

By Hiroshi Inoue

     TOKYO (MNI) - Bank of Japan officials believe the BOJ's massive purchases

of exchange-traded funds (ETFs) aren't healthy for stock market pricing but are

cautious about publicly reviewing the program, which could send the wrong

message about the bank's commitment to achieving its 2% inflation target, MNI

understands.

     The officials are concerned that any decision by the central bank to review

its ETF buying policy could set off a downtrend in the domestic stock market,

which in turn would hurt buoyant business and consumer sentiment.

     However, they are considering whether they could link the pace of ETF

purchases to an indicator, such as the bank's estimate of risk premiums in the

stock market.  This would make the purchase program more flexible, as is the

case for its purchases of government debt, which is now linked to yields in the

bond market.

     The possible timing for a review of the ETF purchase framework could come

after next April, when Kuroda's current five-year term ends.

     Kuroda may be reappointed for another term, but, if not, someone with a

similar reflationary policy stance is expected to be appointed to head the BOJ

by Prime Minister Shinzo Abe.

     Either way, the start of a new leadership term (the two deputy governors

are expected to be replaced) will provide the central bank an opportunity to

review its entire monetary policy program, BOJ officials believe.

     BOJ officials expect the impact on the stock market of any unwinding of ETF

buying would be limited, because Japanese economic fundamentals remain sound due

to rising corporate profits.

     The pace of asset purchases is no longer the main target of the BOJ's

easing policy.

     Under the yield curve control framework adopted in September 2016, the BOJ

has been trying to stabilize the 10-year government bond yield, the benchmark

for long-term borrowing costs, at around zero percent and keep the overnight

interest rate at -0.1%.

     The BOJ has retained its limit to buy Y80 trillion in JGBs each year to

help form a yield curve that is appropriate for the economy, but when the JGB

yields drop, the BOJ has slowed the pace of its JGB purchases.

     The BOJ is also committed to buying ETFs worth Y6 trillion annually to

maintain the degree of monetary easing, regardless of the performance of the

domestic stock market.

     But unlike the relationship between JGB yields and JGB purchases, there is

no direct link between ETF purchases and interest rates, which means the BOJ

cannot reduce the scale of its ETF buying without reviewing the current policy

stance.

     Should the BOJ review its ETF buying policy, it would need to present an

indicator that would help it assess whether the pace of its ETF purchases is

appropriate for maintaining the degree of ease and whether it is distorting the

stock market excessively.

     The BOJ's ETF buying is widely believed to have distorted Japanese stock

prices but BOJ officials don't think the rise in the Nikkei 225 stock index

signals overheating, judging from price earnings ratios (PER) and economic

fundamentals.

     The Nikkei 225 stock index PER is around 14 times, compared with 18 times

seen in early 2000s, according to an estimate by the BOJ.

     BOJ officials believe that risk premiums -- which it estimates based on the

PER, economic fundamentals and interest rates -- are lower than the level in

July 2016, when the bank increased the pace of its ETF purchases.

     Despite warnings from some board members about the side-effects of

continued large-scale monetary easing, there are no signs that the board is

considering reviewing the pace of ETF purchases at the moment.

     But should the BOJ review its ETF buying next year, it would justify a

reduction in purchases due to a drop in risk premiums, BOJ officials believe.

     The BOJ doesn't directly buy ETFs from the market. Instead, it buys them

through trust banks, which monitor corporate behavior.

     In July 2016, the BOJ increased the scale of its purchase of ETFs to Y6.0

trillion from Y3.3 trillion not only to stabilize financial markets but also to

lower risk premiums that were pushed up by Britain's decision to leave the

European Union.

     The BOJ has been buying ETFs since late 2010, more than two years before

its aggressive easing program began, and the outstanding balance of ETFs bought

by the BOJ topped Y16 trillion at the end of November this year, BOJ data show.

     These purchases have made the BOJ a large shareholder of some major firms

listed on the Tokyo Stock Exchange, including Fast Retailing, the parent company

of the Uniqlo retail apparel chain, and the electronics company TDK, according

to press reports.

     The percentage of Japanese ETFs owned by the BOJ is about 70% but it will

change as new ETFs are produced.

     In theory, the scale of ETFs could rise to Y500 trillion, which is

equivalent to the total volume of stocks listed on the Tokyo Stock Exchange.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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