MNI INTERVIEW: BOJ Eyes Tiering Options Ahead Of Rates Move

The Bank of Japan is looking at options to replace its three-tier system of interest on bank reserves, potentially opening the way to an exit from negative overnight rates by as soon as December if officials are confident they can avoid prompting market perceptions of tightening policy, a former BOJ board member told MNI.

After potentially increasing its overnight rate, the BOJ is then probably aiming to wait until after March before dismantling yield curve control, Makoto Sakurai said in an interview.

The BOJ’s current tiering system, introduced in January 2016 together with negative rate policy, charges -0.1% on excess reserves, as well as paying zero and a positive rate on the other two tiers. The negative tier could be removed at the end of the year, according to the former board member who left the BOJ in 2021. “The key issue is how will the BOJ manage the positive interest rate for financial institutions’ current account balances,” he said. “Bank officials are apparently considering various options. If the idea takes shape, the BOJ could remove the negative rate policy in December.”

The BOJ has to consider the political implications of any such move as well as to be sure that it can be presented within a context of maintaining easy policy, Sakurai added. “The negative interest rate is a symbol of ultra-easy policy, so there is the risk that removing the negative interest rate will be interpreted as meaning that the Bank is phasing out its easy policy and shifting to a tightening phase,” he said, though he added that Japan’s economy continues to recover, with a steepening of the yield curve following the BOJ’s move in October to drop the 1% limit for the 10-year yield, and to treat it as a reference point. (See MNI BOJ WATCH: BOJ Relaxes YCC, Sees Limited Rise In Yields)

“Removing the negative interest rate will not have a serious adverse impact on the economy and financial markets, or on businesses,” said Sakurai, who in July had expected a shift away from yield curve control by as early as December. (See MNI INTERVIEW: Ex-BOJ Sakurai Expects Q4 YCC Adjustment)

UEDA SAYS SEQUENCING UNCLEAR

BOJ Governor Kazuo Ueda said last week that the BOJ would be very careful about tightening, in order to avoid a bond-market selloff which could harm financial institutions, and that it was too early to determine the sequence of policy moves.

It is now clear that the Bank is more likely to maintain the yield curve control framework after first drop its negative rate policy, in order to limit subsequent bond market spillover, said Sakurai, though he added that the BOJ could raise the reference level of the 10-year yield to around 1.25% by as early as March

The neutral level of 10-year rates, the level compatible with stable inflation, is around 1.4% or 1.5%, he said, noting that real interest rates are very low now that inflation is picking up, with the 10-year real interest rate at around -2.8%, compared to 2.64% in the U.S.

The BOJ will base much of its opinion on whether domestic inflation is becoming self-sustaining on the results of the first wages survey by trade union federation Rengo available in mid-March, though Sakurai noted that this survey reflects the situation at larger businesses and that the BOJ should not neglect the smaller companies which employ 70% of workers.

“If the BOJ board’s median forecast for inflation is close to 2% in the next Outlook Report in January, it will pave the way for the BOJ to tweak the YCC in March,” Sakurai said.