MNI POLICY: New BOJ Gov Must Keep Rates Low, Ensure Recovery

The three leading candidates to be the next Bank of Japan governor need to be sensitive to the importance of low interest rates embedded in the economic policies of the Kishida administration and be alert to the risks of derailing Japan's economic recovery from any tweaks to decade-long easy policy, MNI understands.

The backgrounds of the contenders offer the government an insight into the possible pace and extent of moves to enhance policy flexibility and restore market functioning, but bank officials - who will advise the new governor - are aware that low interest rates have been built into the government’s economic policies and that the central bank has a responsibility to avoid a sharp increase in the government’s financial burden.

Prime Minister Fumio Kishida has signalled a need to increase the flexibility of monetary policy before the 2% price target is achieved in a stable and sustainable manner. The prime minister is expected to present the candidates for governor and two deputy governors to Japan's Diet next week. BOJ Deputy Governor Masayoshi Amamiya, former Deputy Governor Hiroshi Nakaso, and former Deputy Governor Hirohide Yamaguchi are viewed as frontrunners. (See MNI INTERVIEW: New BOJ Gov Must Quash Normalisation Talk - Momma)

Achievement of the 2% price target will be maintained whoever ascends to the governor's role on April 9 as changing the target could roil financial markets. The BOJ's low interest rate policy will be also maintained. (See MNI POLICY: BOJ Faces Policy Debate If High Inflation Persists)

The new BOJ governor will be required to communicate clearly with market participants to minimise confusion on policy adjustments and avoid triggering a sharp rise in bond yields. Allowing the 10-year bond yield to be determined by markets and scrapping the negative short-term interest rate are significant challenges confronting the next BOJ head.

Even if the BOJ advances policy tweaks, it will pledge to buy government bonds if necessary to not only to curb any sharp rises in bond yields but also to maintain a good relationship with the government.

THE SHORT LIST

If Masayoshi Amamiya takes office, he will likely carry on Governor Haruhiko Kuroda’s policy stance as he has emphasised the need to maintain easy policy to achieve the 2% price target. Amamiya, as Kuroda’s right-hand man, has played a major role in formulating BOJ policy as he has consistently specialised in monetary policy. Bank officials stand ready to fully support Amamiya if he becomes governor.

Amamiya will begin to increase the flexibility of monetary policy as the BOJ's yield curve control policy has produced side-effects in the form of distortions in the bond market. Scrapping the negative interest rate will be a tough issue as it could be interpreted as pivot away from easy policy, which would destabilise markets. The -0.1% short-term interest rate has been symbolic of easy policy, which imposes a high bar for bank officials to justify any adjustment.

Former BOJ deputy governor Hiroshi Nakaso is viewed as likely to focus on the accumulated side-effects of easy policy should he be appointed, and is likely to move to restore the functioning of financial markets more quickly than Amamiya. Nakaso previously stated that Abenomics had relied too much on monetary policy. Nakaso was appointed to an APEC financial advisory body on Thursday.

Should former BOJ Deputy Governor Hirohide Yamaguchi take office, he would promote the flexibility of monetary policy more quickly than Nakaso as Kishida might seek to accelerate the departure from Abenomics in an effort to push ahead with his own economic policy. However, some reflationary lawmakers who belonged to the Abe faction are opposed to a radical change of Abenomics

The BOJ governor has full control over policy decisions, and deputy governors - except for a rare case - fully support the governor’s intention. Bank staff do weigh the input of the deputies in deciding policies.

Bank officials will be required to not only justify policy decisions but also to get agreement from deputy governors like they did in December, when the 10-year yield target band was widened to satisfy reflationist Deputy Governor Masazumi Wakatabe.