MNI POLICY: BOJ Eyes Inflation Flexibility In Accord Review

A review of the joint statement between the Bank of Japan and the government is expected to deliver more monetary policy flexibility but will not lead to an immediate normalisation of policy, with the 2% inflation target and negative short-term policy rate expected to be maintained, MNI understands.

The decade-old joint agreement has come into sharpened focus ahead of the BOJ's new governor starting on April 9, with mounting expectations the wording regarding the timing of the achievement of the 2% inflation target may be revised from "at the earliest possible time" to a medium to longer-term horizon. Japan no longer suffers endemic deflation but the 2% target has yet to be sustainably delivered despite long-term easy policy.

Officials are conscious of balancing the need for more flexibility against the prospect of heightened volatility should markets interpret the change as telegraphing a move away from the easy policy settings viewed as still required to support Japan's economy. The new governor's ability to clearly communicate the nuance of the change will be key in managing market expectations and impacts on the yen and Japanese government bonds.

Even if the wording around the timing of the inflation target was deleted, it wouldn't have any policy implications, a person who is familiar with BOJ monetary policy said. However, deleting the wording may invite market speculation that the BOJ could tweak its policy framework.

Should the government and the BOJ agree to revise the statement, they will pay great attention to the risk that any revision could destabilise financial markets. Changing the 2% price target is very unlikely as it would cause unnecessary volatility in financial markets as the target has come to be accepted globally.

The next BOJ governor must maintain the central bank's low interest rate policy as accommodative policy has been built into the government’s economic policy. Sharp rises in interest rates or policy tightening will not be accepted by the government given its huge debt. (See MNI POLICY: BOJ To Tweak Guidance If Covid Severity Downgraded)

FAREWELL ABENOMICS

Prime Minister Fumio Kishida has indicated the need to revise the statement first inked in 2013 to not only signal a departure from Abenomics but also to increase the flexibility of the 2% price target. Kishida said the government and BOJ must discuss their relationship in guiding economic policy under the new BOJ governor.

His remarks indicated the government may revise the accord, which in turn will pave the way for the BOJ to eventually exit from super-easy policy. The BOJ can tweak the policy framework even before the achievement of 2% price target but it cannot tighten policy, such as removing the -0.1% short term policy rate, which is symbolic of easy policy.

Removing yield curve control would be a tough task for the BOJ because it could trigger long-term interest rates to surge. Even if the BOJ scraps the yield curve policy or shortens the long-term policy interest rate to 5-years, the bank would need to continue to buy Japanese government bonds to curb higher bond yields. (See MNI BOJ WATCH: Kuroda Dismisses Market Speculation On YCC Hike)

Former BOJ Governor Masaaki Shirakawa, who was involved in the 2013 statement, said in contribution to a weekly magazine that he doesn’t see the need to revise the statement hastily. He said open debate and analysis were necessary to make a conclusion on a revision of the accord. Shirakawa added that the joint statement includes a logic that enables the BOJ to manage monetary policy in a flexible manner regardless of the 2% price target.