MNI INTERVIEW: Flexible CPI Horizon Key To YCC Tweaks-Yamamoto

The Bank of Japan's new governor must change the timeframe of the 2% inflation target as a key step towards reviewing its yield curve control policy that has produced negative side-effects like impaired bond market functioning, former BOJ executive director Kenzo Yamamoto told MNI.

“The BOJ had considerably worsened the functioning of financial markets and the bank should manage monetary policy based on economic and price moves,” said Yamamoto, who is now the representative for KYinitiative.

He said the BOJ is unable to adapt a more flexible approach to monetary policy because it has pledged to maintain the current easy policy until the 2% price target is achieved in a stable and sustainable manner, he said.

“Unless the BOJ changes the rigid price target, the bank will not head towards the next step. If the BOJ changes the price target to a medium- to long-term target, it will lead to a review of yield curve control,” Yamamoto said.

He said it’s dangerous to place absolute trust in a rigid inflation target and there is no central bank that manages its inflation targeting in such an inflexible way. He said financial market functioning had fallen considerably as a result of the bank’s policy of keeping long-term interest rates at low levels for a prolonged period. (See MNI POLICY: BOJ Wary As 10-Year Yield Rise Hits Some Banks)

“The BOJ must achieve the two issues, such as creating an environment that enables the BOJ to manage monetary policy based on economic and price moves, and gradually leaving long-term interest rates to markets,” Yamamoto said.

He added it will not be easy for the BOJ to gradually adjust long-term interest rates as market participants tend to push long-term interest rates higher once the bank begins to adjust rates, as was seen when the band around the 10-year yield target was widened to 50bp from 25bp in December.

Yamamoto said the new BOJ new governor confronts an environment of diminished fiscal discipline and a weakened financial system due to decade-long easy policy. His comments come as Japan's government is set to unveil its nominees for the next BOJ governor and two deputy governors. Deputy Governor Masayoshi Amamiya is viewed as the frontrunner for the top job. (See MNI POLICY: New BOJ Gov Must Keep Rates Low, Ensure Recovery)

INFLATION WORRIES

Yamamoto was also wary of the prospect of an acceleration in Japan's inflation and the possible impact on financial institutions.

“Looking ahead, if Japan’s core CPI is stable at around 2%, the BOJ will not need to sharply raise interest rates. The possibility may not be big…[but] if the rise in CPI accelerated, the BOJ will have to sharply raise interest rates, which in turn will considerably worsen financial conditions at financial firms,” he said, adding any rise in inflation would also cause confusion in financial markets. (See MNI POLICY: BOJ Faces Policy Debate If High Inflation Persists)

The BOJ actions had prompted market participants to buy longer-end bonds and increase investment in foreign bonds, known as portfolio rebalancing, Yamamoto said. This would eventually contribute to lowering overall interest rates and weakening the yen, exactly what the BOJ intended, he said.

The BOJ will need to adjust the negative interest rate based on economic and price data, though any move to adjust the short-term interest rate would need to be done more cautiously than changes to the long-term interest rate, Yamamoto said.

“Even if the BOJ raises the short-term interest rate to zero percent from -0.1%, it will not be much difference. However, the negative interest rate is a symbol of easy policy, so the BOJ is required to be cautious in adjusting the negative interest rate,” he said.