MNI POLICY: BOJ Needs More Flexibility As Easing Maintained

The next Bank of Japan governor should implement a policy framework that maintains current easy policy but provides greater medium to longer-term flexibility ahead of an eventual exit from easy policy, former officials told MNI.

The new governor, who will take office in April, needs to consider how to balance the need to support Japan's growth but also map an eventual exit from negative short term rates and yield curve control without spooking global financial markets.

Tweaks or changes to easy policy are unlikely immediately after the appointment as the BOJ's 2% price target will not be achieved over the next few years. The failure to deliver the 2% price target in a stable and sustainable manner will prompt the BOJ to maintain easy policy to support growth and create an environment for firms to raise wages. (See MNI INTERVIEW: BOJ's 2% Target Isn't "Appropriate" - Yamamoto)

In seeking a flexible policy framework, the BOJ must pledge to maintain easy policy to prevent market participants from preemptively speculating on an exit from easy policy.

The new governor should show initiative by instructing BOJ staff to consider measures to increase the flexibility of monetary policy over the medium to long term view, a former senior BOJ official, who requested anonymity, said.

The BOJ sharply increased the scale of Japanese government bond purchases without considering the consequences, another former official, speaking on the condition of anonymity, said.

The central bank will not be able to reduce the balance of its holdings easily as the remaining life of JGBs held by it is considerably long, he said. However, the BOJ cannot sell bonds through outright operations.

He said escaping easy policy would be very tough and it may confuse and destabilise financial markets, especially JGB markets. This will require the BOJ to continue to buy JGBs during the process of exiting easy policy.

INFLATION THREAT

A central bank always must ensure it has a plan to return to normal monetary policy whether interest rates are significantly lowered or raised, the second person said. He said the BOJ had conducted monetary policy haphazardly over the past 10 years and would pay dearly for its policy management.

The new governor should pay attention to the risk the bank misjudges the threat of inflation based on past periods of disinflation, similar to other central banks. The Federal Reserve and the ECB judged inflation based on years of disinflation and missed the signs of inflation, and as a result, they fell behind the curve in the conduct of monetary policy, the first former official said.

He warned that the BOJ could make the same mistake if it continues to assess inflation based on past economic and price assessments. The BOJ maintains that the year-on-year pace of Japan’s core consumer price index will fall below 2% in fiscal 2023, starting in April. Bank officials attributed the forecast slowing in inflation to waning pass-through to consumer prices of cost increases, led by rising import prices. (MNI POLICY: BOJ Worries High Costs Will Hurt Q1 Spending)

The BOJ’s inflation estimates are based on the assumption that high inflation in the U.S. and Eurozone will fall and move towards 2% following rate hikes by central banks, a different former senior official said on condition of anonymity. The person, however, added that it is questionable whether U.S. and European CPI will fall as smoothly as BOJ officials expected.