BoJ bumps against the limits of easing

Has the BoJ made a tacit admission its QE program is increasingly ineffective, and its side-effects damaging?

The much-anticipated next phase of Bank of Japan’s most unconventional monetary policy has been unveiled. It’s a tweak rather than another aggressive move further into unchartered territory.

In some respects, the Bank of Japan’s decisions are a tacit admission that its supercharged quantitative easing program has become increasingly ineffective and the “unintended consequences’’ for its financial intermediaries increasing damaging.

Ahead of the meeting there had been speculation that the central bank would push its benchmark rate, now at negative 0.1 per cent, further into negative territory. Some thought it might abandon its 2 per cent inflation target, given that Japan is again experiencing deflation. There was even talk of “helicopter money.’’

In the end, after a comprehensive review of its near four-year program of massive purchases of bonds and, more recently, its negative interest rates, the bank chose to finetune its existing programs rather than experiment further.

It also continues to refuse to accept that the policies aren’t working, blaming the failure to achieve the inflation target on exogenous factors like the plunge in oil prices, weak global growth and volatile financial markets.

So, it decided to keep the benchmark rate at negative 0.1 per cent, while not abandoning the possibility of moving deeper into negative territory in future. It is maintaining the size of its asset purchases at their current level of ¥80 trillion a year. It has removed a target time frame for achieving its goal of 2 per cent inflation, which had previously been pushed out to 2017.

Most significantly, it has got rid of the maturity target of seven to 12 years within its bond-buying program.

A key outworking of quantitative easing programs, one that is gaining increased visibility after eight years of increasingly unconventional policies by the world’s major central banks, is the impact negative rates and bond-buying programs have on financial institutions.

Japanese banks and insurers and pension funds have — like their counterparts in Europe and the US — begun complaining loudly that negative rates and flat yield curves are draining their ability to generate profit and capital and their capacity to lend. For insurers and pension funds the policies reduce their investment returns while increasing their liabilities, eroding their solvency margins.

Those impacts were acknowledged quite recently by the Bank of Japan’s governor, Haruhiko Kuroda.

It is instructive that the immediate response of Japan’s financial markets to today’s decisions was to push Japanese bank shares sharply higher.

The scrapping of the maturity target for its bond buying and foreshadowing buying of bonds with a wide range of maturities, with the aim of keeping the 10-year government bond rate around zero, is being interpreted as an attempt to shape Japan’s yield curve to give it a steeper profile.

More broadly, the relatively modest nature of the changes to the policy is seen as evidence that Japan — which, confronted with decades of economic stagnation, was conducting experiments with monetary policy in the early 2000s, well before the financial crisis — that quantitative easing has limitations. It’s why central bankers and the global financial authorities have been urging governments to adopt more aggressive fiscal policies and structural reforms.

The Bank of Japan’s announcement is one of the two key central bank meetings occurring this week, with the US Federal Reserve’s Open Market Committee starting its two-day meeting yesterday.

While there is no real expectation of a US rate rise emerging from the meeting (although there are some who haven’t ruled it out), the language of the decision and the expectations revealed by the Fed’s ‘’dot plot,’’ which sets out the members’ expectations for future movements in US rates, could have a significant impact on financial markets.

It isn’t likely that the Fed would move during November, given the coincidence of its next meeting with the US presidential election, but its December meeting is — like last year’s — definitely a ‘’live’’ one. The markets will want to see if the Fed uses the current meeting to forewarn it of a December move.

It has been apparent in the lead-up to the current meeting that the ‘’hawks’’ within the Fed are becoming more hawkish and strident in their views that the US needs to take steps to normalise its monetary policy and that the ‘’doves’’ are remaining dovish and arguing more openly for maintaining ultra-low US rates against a backdrop of mixed US economic data.

Any perceived shift in the balance between the camps that emerges from the meeting could have a significant impact on financial markets which, after several months of extremely low levels of volatility, have become far more volatile in recent weeks as the debate about a Fed rate hike intensified.

The Japanese will be encouraged that the Yen weakened modestly after the Bank of Japan’s announcement today.

The Fed is increasingly cognisant of the global and financial markets contexts in which it is deliberating.

It is sensitive to the impact on the US dollar of the decisions it and its central bank peers elsewhere take — even though central bankers everywhere pretend they aren’t trying to keep a ceiling on their currency.

It would be mindful that expectations of a US rate rise this year could have an exaggerated impact on the dollar and US competitiveness — and both markets and the emerging economies that have gorged on US dollar-denominated debt — while the Japanese and Europeans maintain their aggressive quantitative easing programs.