Japan

Understanding the BOJ Decision in Six Simple Questions

9/21/16
from The Wall Street Journal,
9/21/16:

In a policy revamp, the BOJ hopes to control the yield curve.

The Bank of Japan said it would target a zero yield for 10-year government bonds—deploying a new tool in its fight against deflation. Gov. Haruhiko Kuroda, who also has cut short-term interest rates below zero, said controlling the yield curve was now the central part of his plans. What has the BOJ done so far? Like many central banks, the BOJ has bought bonds with the aim of pushing down borrowing costs. That encourages companies and households to borrow, stimulating the sort of economic activity that will push up prices, they hope. What’s the problem?

The BOJ’s bond buying has brought long-term borrowing costs close to short-term costs—what is known as flattening the yield curve—in a way that the central bank says “may have a negative impact on economic activity.” Extremely low interest rates on long-term lending could reduce banks’ incentive to lend money because they aren’t making money on charging interest.

What does the BOJ want? It wants the 10-year yield to be around zero, allowing the bank to have negative yields on short-term debt, while maintaining a gap between short and long—especially some of its very-long-dated debt. By doing so, it can help the banks, insurers and pension funds that objected to the previous policy. How will they do this? The bank used to target an average maturity of 7-12 years on its bond purchases. Sticking to that meant it was buying long-term debt, even if it flattened the curve. It now can buy across the curve in a way that keeps longer-term yields higher than short-term ones.

Will the BOJ’s new strategy work? Some investors seem to think so. Bank shares in Japan closed up nearly 7% after the announcement, but the longer-term effect is unclear. The scale of the Bank of Japan’s intervention in the bond market is far bigger than that of the Federal Reserve or any other central bank, so this is uncharted territory.

Could the BOJ actually sell bonds to push up the 10-year rate if it falls? That is not clear, though doing so would amount to raising borrowing costs—something the bank doesn’t want. In its statement, the bank talked about purchasing bonds to keep the 10-year yield at “more or less” where it is now. It didn’t explicitly discuss selling. Presumably, the bank would like to be able to lift the 10-year yield merely by buying fewer bonds than previously expected. The bond-purchase program is so enormous that any selling is likely a long way away.

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