Bank of Japan has learnt danger of half-measures

GTHE CENTRAL BANK MAINTAINED ITS YIELD TARGETS, SET AROUND 0 PER CENT FOR 10-YEAR TENORS AND MADE NO CHANGE TO ITS POLICY ALLOWING TRADE TO FLUCTUATE 50 BASIS POINTS EITHER SIDE OF THAT, EVEN THOUGH THE MARKET HAD BEGUN TESTING THAT LIMIT RIGHT AFTER IT WAS IMPLEMENTED LAST MONTH.

o v e r n o r Haruhiko Kuroda’s battle with market forces has entered a new phase. The Bank of Japan (BOJ) made no adjustments to its yield-curve control (YCC) policy that keeps interest rates ultra-low on Wednesday.

That is stinging traders who bet the central bank would be forced to widen a 10-year government bond’s trading band again, having expanded it to 0.50 per cent from 0.25 per cent in December under market pressure.

However, that tweak’s failure to reduce the need of central bank intervention has left the BOJ with little appetite for more compromises.

At its meeting, the central bank maintained its yield targets, set around 0 per cent for 10-year tenors and made no change to its policy allowing trade to fluctuate 50 basis points either side of that, even though the market had begun testing that limit right after it was implemented last month. That’s why some investors expected the BOJ would offer yet another adjustment by perhaps widening the band to 0.75 per cent.

Instead Kuroda rolled out a new tool to hold interest rates down, signalling intervention will continue. The central bank spent 10 trillion yen ($77 billion) buying bonds on Friday and Monday alone, according to an analysis, and it already owns more than half the sovereign fixed-income market.

The yen softened as much as 2.6 per cent against the dollar in response before pulling back, while bond traders pulled the benchmark yield down to 0.41 per cent, well within the band.

The BOJ’S policy stubbornness reflects intractable realities. Whatever Kuroda does, it hurts, including doing nothing.

The real Japanese economy is in rocky shape and inflation data is muddy.

In that context, policymakers have cause to await spring wage negotiations — and perhaps Kuroda’s retirement in April — before concluding that a sustained demand-driven price rise is underway and sufficient to justify higher rates.

Until then, the current policy template will continue to smother bond market liquidity and distort corporate lending rates, which is how the BOJ justified its decision to widen the trading range on December 20.

The market’s rejection of Kuroda’s attempt to buy time may have persuaded him that further half-measures would put him on a slippery slope towards a de-facto interest rate hike that would inhibit economic recovery.

If the US Fed stops hiking ahead of schedule, say, or spring wage negotiations go particularly well, his patience will look prescient. If not, his successor may inherit a market mess.