We anticipate that the Bank of Japan (BOJ) will announce no new actions at this week's press conference, and it may even wait until the second half of 2017 to discuss its next policy shift. BOJ Governor Haruiko Kuroda will remain upbeat on inflation but will continue to maintain that it is far too soon for the BOJ to consider raising its yield target.
The central bank retains its optimistic view on Japan's inflation path in a continued bid to coordinate higher expectations from the market. Yet the very slight reflation we have seen so far in Japan has been driven more by rising commodity and import prices than any substantive wage growth. Underlying inflation dynamics and indicators remain weak, and corporate concerns about protectionism will keep wage increases down, despite a weaker yen and higher resulting profits. Consequently,
We expect the BOJ will maintain its 10-year JGB yield target at around 0%
inflation remains more or less range-bound and again raises questions about the BOJ's ability to reach its 2% price-stability target.
The BOJ's approach to yield-curve targeting aims at preserving the current level of interest rates and steepness of the yield curve. Lower rates across the curve, as well as the latest acceleration of credit demand from corporations, suggest that this policy is working so far. However, a credible targeting mechanism might require fewer bond purchases in the future, leading to a slower increase in the monetary base going forward.
The BOJ's decision to publish a schedule of regular quantitative-easing purchases has helped calm market worries of possible imminent policy adjustments. However, in a clear sign that the BOJ is running out of ammunition, the central bank has started to lose pace against its stated annual Japanese government bond purchase target of JPY 80 trillion. Instead, it will conduct purchases in a flexible manner going forward – a shift from the monthly JGB purchases of approximately JPY 8-12 trillion before. Moreover, in order to manage the slope of the curve, the BOJ has recently switched from buying JGBs with one- to five-year maturities to those with maturities between five and ten years.
The BOJ's approach to yield-curve targeting aims at preserving the current level of interest rates and steepness of the yield curve
And with higher rates expected in the US and global inflation expected to edge up, maintaining the BOJ's yield-curve target will become increasingly difficult.
As a result, we expect the BOJ will maintain its 10-year JGB yield target at "around 0%". However, if the yen-to-dollar rate markedly weakens, it will become increasingly likely that the BOJ will raise its target for 10-year JGB yields. In the months to come, the BOJ will have to prepare the market for an increased yield-curve control target by widening the fluctuation range for the 10-year yield to around +/- 0.20%, gradually hiking the midpoint for this target range in 10- to 20-basis-point increments. Consequently, we will be watching the press conference closely for any indications Mr. Kuroda is paving the way for future yield-target adjustments.