MNI INSIGHT: BOJ Real Rates Are Key Tool; Extended QE Unlikely

--BOJ Not Ruled Out Deepening Negative Rates, But Pros/Cons To Be Weighed

By Hiroshi Inoue

     TOKYO (MNI) - Lowering real interest rates will be the Bank of Japan's main

policy option if there is a need for further easing, with Bank officials

unconvinced as to the benefit of extending quantitative easing, MNI understands.

     BOJ officials maintain the view that Japan's economic activity and prices

have picked up as a result of lower real interest rates, and should downside

risks increase prompting further action, that should remain the preferred way

forward, enabling firms to raise funding at a lower cost.

     Experience has taught the BOJ that quantitative easing hasn't stimulated

economic activity and boosted the inflation rate, with officials still uncertain

how increasing the money supply has boosted inflation.

     It is unlikely that the BOJ returns to QE, as they feel the transmission

mechanism is unverified, including exactly what the impact is on the economy and

inflation rates.

     --CONTINUE FOR NOW

     But the BOJ will continue expanding the monetary base until the

year-on-year rate of increase in the observed CPI (excluding fresh food)

exceeds2% and stays above the target in a stable manner under their

"overshooting commitment".

     There is some concern amongst BOJ officials that lowering real interest

rates may also have limited impact, as rates have already been at very low

levels for a prolonged period and both firms and households are now less

sensitive to moves.

     However, they feel lengthening forward guidance on easy policy from "for an

extended period of time" policy is another option available if the need arises.

     --NOT RULED OUT

     Another option, not yet entirely ruled out by the Bank, is to further lower

the negative short-term interest rate target from the current -0.1%. However,

officials and board members are acutely aware of the debate around the

side-effects -- such as lowering profitability at commercial banks -- and will

carefully weigh the pros and cons before a further cut.

     BOJ officials believe an increase in the monetary base, along with central

bank lending to banks at negative rates, can help mitigate some side effects of

deepening negative nominal rates. But the officials are concerned that the loan

rates for commercial banks could be seen as a subsidy to them and eventually

lead to calls for the banks to pass on negative rates to customers.

     Those officials are also concerned over the risk that increasing the

monetary base will have greater downward pressure on nominal interest rates than

when increasing the monetary base back in 2014.

     Keeping all options open, BOJ Governor Haruhiko Kuroda has cited lowering

the short- and long-term interest rates, expanding the asset purchases and

accelerating the expansion of monetary base as additional policy measures

available under the yield curve control policy.

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

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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