REPEAT: MNI INSIGHT: Some At BOJ Eye Unwind Due Side-Effects

Repeats Story Initially Transmitted at 08:05 GMT Nov 10/03:05 EST Nov 10

By Hiroshi Inoue

     TOKYO (MNI) - Some Bank of Japan officials are increasingly concerned about

the side-effects of prolonged large-scale monetary easing to the point of hoping

for signs of economic or financial overheating so they can justify beginning to

unwind their massive accommodation, MNI understands.

     These officials believe a gradual unwinding is becoming increasingly

necessary because the aggressive easing, which has lasted for over four years

and is set to continue at least for another few years, has distorted incentives

and so caused negative side-effects to accumulate. They also think the BOJ needs

to create room for another round of easing if the economy were to be hit by a

large shock.

     Signs of overheating in economic or financial activity is believed to be

the only thing that would justify the BOJ board beginning to unwind its easy

policy before it can anchor inflation around 2%.

     Internally, BOJ board members have been warned about commercial bank's

looser lending practices and the continued run-up in stock prices. These are not

yet seen as signaling overheating but some officials believe they are close to

doing so.

     This may explain why more BOJ board members have resumed calling for a

close watch on side-effects, as shown in recent speeches and in the latest BOJ

board meeting minutes and summary of opinions. This comes after the departure of

Takehiro Sato and Takahide Kiuchi, the last remaining skeptics of aggressive

easing, who continued to warn of side-effects until they left the BOJ on July 23

at the end of their five-year terms.

     The recent drop in the scale of the BOJ's purchases of Japanese government

bonds has been described by some market observers as a partial unwinding. But it

is rather a reaction to a decline in JGB yields that necessitated the BOJ

trimming its purchases to maintain its yield curve targets and does not reflect

any intention by the central bank to curb easing.

     It is clear that should upward pressure on JGB yields rise, the BOJ would

increase its JGB purchases to keep the current yield curve shape based on the

short-term interest rate at -0.1% and the 10-year JGB yield around zero percent.

     In the view of some officials, the BOJ is trapped in its commitment to

continue large-scale monetary easing until inflation stabilizes around its 2%

target. These officials now wish to see clear signs of excessive economic or

financial activities emerge, paving the way for the board to consider unwinding

its easy policy.

     So far, this is not the case.

     The BOJ's latest risk assessment in its semi-annual Financial System Report

published Oct. 23 -- "No imbalances in financial and economic activities can be

observed on the whole while the funding conditions for the nonfinancial private

sector have been highly accommodative" -- gives the board no reason to change

current policy.

     Some BOJ officials worry that by the time they can confirm that economic

and financial activities are overheating, it may be too late to begin the

process of unwinding.

     The BOJ, as a whole, is aware of the risks, but as yet hasn't seen any

evidence of them materializing.

     The heat map in the Financial System Report showed no excessive financial

activities, with all 14 items in the report colored "green," indicating no

danger.

     But two of the 14 diffusion indexes -- on the lending attitude of financial

institutions and on stock prices -- were close to being colored "red," which

would require closer attention. There is no "yellow" warning color in the heat

map.

     This latter information -- that the two indicators were showing higher

risks -- was not included in the report but MNI understands that it was shared

with the board before the Financial System Report was released and thus ahead of

the last policy meeting.

     BOJ officials worry that it is difficult to clearly assess financial

imbalances through regular data.

     Some officials are worried in particular about rising unhedged investments

in foreign currency securities by regional banks and life insurance companies.

Given the current very low yields on Japanese government bonds, institutional

investors are shifting their investments to foreign bonds, some unhedged.

     BOJ board member Yukitoshi Funo told reporters Wednesday that there are no

remedies without causing side-effects. The BOJ needs to pay attention to

potential side-effects of easy policy and balance the costs and benefits, he

said.

     BOJ Deputy Governor Hiroshi Nakaso also raised the subject in a speech in

New York on Oct. 18.

     "Given that QQE (quantitative and qualitative easing) is unprecedentedly

powerful, due attention also has to be paid to side effects that could

materialize going forward," Nakaso said. "If an excessive decline in and a

flattening of the yield curve were to last for too long under powerful monetary

easing, risks of a pullback in financial intermediation and of a destabilizing

of the financial system through downward pressure on financial institutions'

profits could not be ignored."

     "If these risks were to materialize, the transmission mechanism of monetary

easing would be hampered and it would become more difficult to achieve the 2%

price target and sustainable economic growth in a self-fulfilling manner," he

said.

     The summary of opinions expressed at the bank's latest policy meeting on

Oct. 30-31 released Thursday showed that one board member warned about the BOJ's

large asset purchases, which critics say have been distorting financial markets.

     "The policy effects and the possible side-effects of the purchases of risky

assets including exchange-traded funds (ETFs) should be examined from every

angle," the unidentified member said.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com