On Wednesday both the Federal Reserve and the Bank of Japan decided upon leaving interest rates on hold. However, the BOJ shifted the focus of its monetary stimulus from expanding the money supply to controlling interest rates. Its policy announcement had two main parts. First, it committed itself to continue expanding the monetary base until the inflation rate “exceeds the price stability target of 2 percent and stays above the target in a stable manner.” Second, it will start targeting the yield on ten-year Japanese government debt (JGBs), while continuing to buy about 80 trillion yen in JGBs annually.
A decision that former Fed Chairman, Ben Bernanke, found puzzling given the curent policy looks to both setting a price and buying a given amount at any price but he believes «that the BOJ was concerned that dropping the quantity target would lead market participants to infer (incorrectly) that the Bank was scaling back its program of monetary easing. Over time, assuming that the BOJ does adhere to its new rate peg, the redundant quantity target is likely to become softer and to recede in importance. The BOJ’s communication will accordingly begin to emphasize the yield on JGBs, rather than the quantity of bonds in the BOJ’s portfolio, as the better indicator of the degree of monetary policy ease.»
According to Tomoya Masanao, Head of Portfolio Management Japan at PIMCO, «the decision is in part a reflection of the BOJ’s recognition that base money expansion itself has little easing effect and that Japan’s neutral yield curve, which is neither expansionary nor contractionary for the economy, is steeper than the bank would have thought. The actual yield curve should not be too flat relative to the neutral curve otherwise the economy will be negatively affected through weakening of financial intermediation.»
Paul Brain, Head of Fixed Income at Newton Investment Management commented: “This is no bazooka from the BoJ but it’s an interesting approach nonetheless. Targeting long term rates as well as short rates reminds us of the period in the 1940s and 1950s when the US fixed 10 year government borrowing rates. It opens the door for more government spending finance at very low rates without further undermining the banking system.” While Miyuki Kashima, Head of Japanese Equity Investments, BNY Mellon Asset Management Japan said he believes the mid to longer-term prospects for the Japanese equity market remain attractive «as the domestic economy is at a rare transitional phase, moving from a period of contraction to one of expansion. The market sell-off this year has been largely due to external factors, and while Japan will be affected by any global slowdown for a period, the country has a large domestic base and can weather such turbulence much better than most economies. Contrary to Japan’s image as export dependent, reliance in terms of GDP is only about 15%, much smaller than most countries in Asia or Europe. The lower oil price is positive for corporate profits overall.’