MNI POLICY: BOJ To Pursue Mkt Friendly Hikes After Policy Exit

The Bank of Japan will likely gradually raise its overnight rate to 1% after it moves away from negative levels, but will likely avoid signalling a clear hiking path amid uncertainty over the level of the neutral rate of interest and concern tighter policy might overly strengthen the yen, MNI understands.

As the removal of negative rates draws closer, bank officials are considering how high the bank could theoretically raise its short-term policy interest rate after the adjustment. Economic and price developments will drive the pace of hikes, however, bank officials want to see the policy rate rise to at least 1% to revive market function.

Bank officials believe the BOJ will find raising the rate to this level difficult. Former Governor Toshihiko Fukui aimed to raise the policy interest rate to 1% in March 2006 when he ended quantitative easing and set the unsecured overnight call loan at zero percent. The BOJ proceeded to raise the rate to 0.25% in July 2006 and 0.50% in February 2007, but failed to increase it further.

MNI has reported the Bank could move away from negative rates as early as March on strong wage data, however, an April exit remains more likely. (See MNI POLICY: BOJ May Consider March Policy Change On Strong Data) It has held the rate at -0.1% since February 2016.

The BOJ views the removal of the negative interest rate as a rate hike, meaning it will continue to raise the policy rate to neutral gradually.

YEN SENSITIVITY

Economic uncertainty and concern over yen appreciation will prevent the BOJ from showing a clear path for rate hikes. The bank, however, will pledge to maintain accommodative financial conditions.

Bank officials believe removal of negative rates will not cause the yen to appreciate sharply unless the bank indicates further rapid hikes. This, alongside economic uncertainty, will prevent the BOJ from showing a clear path for rate hikes.

The Bank must also consider how to deal with its various tools, such as purchases of Japanese government bonds (JGB) and risk assets, the inflation overshooting commitment and the rate of special lending facilities currently at zero percent. While the bank is expected to cease purchases of exchange-traded funds and Japan real estate investment trusts, it will likely not detail plans to sell those assets or immediately reveal quantitative tightening measures.

The BOJ will continue to buy JGBs to stabilise financial markets as long-term rate surges will considerably increase the financial burden at commercial banks and the government. Bank officials believe markets have already factored in the end of negative rates, so they do not expect the 10-year interest rate to rise sharply when it occurs unless market players believe the BOJ could move faster than anticipated.

Governor Kazuo Ueda has said the Bank will aim to avoid major market disruptions when it exits its easy policy settings. While the governor in January highlighted progress toward achieving the Bank’s 2% price target, he gave no hints on whether it would remove the negative interest rate at its upcoming March 18-19 or April 25-26 meetings.