MNI INTERVIEW: Leave 10-Year JGBs To The Market-Ex-BOJ Aide

Risks of a surge in long-term interest rates need a step-by-step process from the Bank of Japan to end its commitment to overshoot the 2% sustained inflation target and allow the pricing of benchmark government bonds directly by the market, a former BOJ executive director said.

"The BOJ’s policy of sticking to a 10-year interest rate around zero percent for a prolonged period has accumulated the significant risk of surging long-term interest rates in the future," Kenzo Yamamoto, now the representative for KYinitiative, told MNI, see: MNI STATE OF PLAY: BOJ Kuroda Rules Out Early Tightening.

"If the BOJ lifts the 10-year policy interest rate around zero percent after achieving the 2% price target in a stable manner, the 10-year interest rate will rise sharply, which in turn will have a big negative shock on the nation’s financial system."

LOOKING AHEAD

MNI understands that BOJ officials are already looking at whether accepting a higher 10-year yield on Japanese Government Bonds (JGBs) and focusing yield-curve efforts on shorter-dated bonds, or broadly lowering the yield curve while leaving 10-year rates to the market, could cause confusion.

“In order to avoid facing such a situation, the BOJ should leave the long-term interest rate to markets and restore the functioning of JGBs,” Yamamoto said.

Yamamoto is not alone in questioning easy policy. A former Bank of Japan governor Masaaki Shirakawa in January told the Nikkei that prolonged easy monetary policy is failing to have the expected impact.

At the same time, BOJ Governor Haruhiko Kuroda has repeatedly said that changes to easy policy are not on the cards now and officials have vowed to defend the yield curve control target (YCC) on expected U.S. interest rates hikes.

Another former BOJ official has even warned of downside price risks and that rapid Fed hikes could cause financial market instability and lead to a stronger yen through safe-haven buying.

TIMING IS IMPORTANT

Yamamoto said the BOJ missed a good opportunity last year to widen the 10-year target range from “between plus and minus 0.25% from the target level" as it had cut the scale of JGB, and ETF (exchange traded-fund) purchases without confusing market players or triggering speculation of policy changes.

In normal market conditions, the BOJ can reduce the outstanding balance of JGBs held by the bank through redemptions and fewer purchases and widen the 10-year interest rate in increments.

But with inflation expectations rising - though still well below the 2% target - any move to curb the expansion of the monetary base goes against the easy policy commitment and calls the easy policy into question, Yamamoto said.

He added there is a "possibility" that CPI gains prove more stubborn in Japan on the back of sharp increases in raw material prices and a weaker yen if the Federal Reserve fails in restricting U.S. inflation.

But the baseline scenario is that higher prices are temporary in Japan, he said.

“The probability isn’t high. But when the BOJ maintains the current easy policy and if the inflation rate is stable at 2%, the long-term interest rate will surge sharply as accumulated upward pressure on interest rates is considerably huge,” he said.