* Market tests BOJ's resolve in meeting new interest rate
* BOJ officials say no range in mind for 10-yr JGB target
* New policy is managed float rather than fixed peg
* Markets expect BOJ to set implicit floor on 10-yr rate
By Leika Kihara
TOKYO, Sept 30 Bond buyers are already testing
the credibility of the Bank of Japan's new monetary policy
framework, pushing 10-year yields below its zero percent target
and giving the bank few palatable options to bring them back on
After failing in its goal of achieving sustained inflation,
the BOJ last week shifted its primary policy tool away from
expanding the money supply and towards controlling the 'yield
curve' - making sure long-term rates remain sufficiently above
currently negative short-term rates so banks can make a profit
from lending into Japan's stagnant economy.
As part of that policy, it pledged to keep the 10-year bond
yield - the benchmark banks use to set mortgage and corporate
lending rates - at "current levels around zero percent".
The market had other ideas, pushing 10-year bond yields to
minus 0.09 percent this week, putting pressure on the BOJ to
take action to bring them back towards its target. tmsnrt.rs/2d6B33l
One such action - reducing the BOJ's own massive bond
purchases - would bring into question a key plank of the
stimulus policy it has been following since 2013 and could have
a much more unsettling effect on markets.
The bank knows markets might interpret any cut in bond
purchases as casting doubt on its commitment to maintain its
money-printing stimulus until inflation overshoots its 2 percent
target. That could trigger a yen spike and hit Tokyo stock
prices, while also hurting consumer price expectations and
investor confidence more broadly.
BOJ officials remain sanguine for now, saying the zero
percent pledge is not so rigid.
"It's not a fixed peg but rather a 'managed float'," said
one of the officials.
The BOJ has used an aggressive bond buying programme, which
runs at 80 trillion yen ($790 billion) a year, to keep rates
down to help the fragile economy, and officials said they would
not rule out buying fewer, or even selling bonds, to prevent
yields from falling too much.
But not everyone is convinced that would work.
"The BOJ can prevent interest rates from rising by printing
money to an unlimited extent. But there's doubt whether the BOJ
can keep them from falling by reducing bond buying," said
Noriatsu Tanji, senior bond strategist at Mizuho Securities.
"Pegging would not work as soon as the BOJ gave up on
reducing bond purchases," he said.
Aware of the dilemma, the market is now testing the central
bank. While the 10-year yield briefly turned positive at 0.005
percent when the BOJ announced the policy, traders pushed it as
low as minus 0.09 percent on Wednesday - barely above the minus
0.1 percent target the bank sets for short-term rates. It stood
at minus 0.085 percent on Thursday.
Financial institutions are confused about the BOJ's
intentions and what it can really achieve.
"Is it really possible to guide long-term rates at a set
level with market operations? Is it appropriate for a central
bank to be doing this in the first place?" said a senior
official at one of Japan's biggest insurance firms, voicing
concern at the market distortions inherent in excessive
Some investors say the BOJ will not allow the 10-year yield
to fall below the minus 0.1 percent short-term policy rate
target, given it does not want the yield curve to flatten.
But sources familiar with the BOJ's thinking say it does not
necessarily see the 0.1 percent negative yield as a floor for
long-term rates as long as yields curve in the right direction.
With the two-year bond yielding minus 0.29 percent and the
five-year yield at minus 0.23 percent, there is no strong reason
to set a minus 0.1 percent floor for 10-year yields, they said.
In judging whether any yield falls are excessive, the BOJ
would look at volatility, yield levels and how long such levels
were likely to persist, the sources said.
"If yields fall below what's acceptable, the BOJ will act,"
one of the sources said, adding that reducing bond buying would
Former U.S. Federal Reserve Chairman Ben Bernanke has warned
of the difficulty of pegging long-term rates.
"Notably, in defending a peg, a central bank gives up
control over the size of its balance sheet, committing to buy
whatever supply of bonds is forthcoming at the target rate,"
Bernanke wrote in a blog on Sept. 21.
"In the extreme case, a central bank trying to hold down
yields could find itself owning most or all of the eligible
Though Governor Haruhiko Kuroda has voiced confidence the
BOJ can control the yield curve, bank bureaucrats say they are
learning as they go on.
Much of the work will involve delicate communication with
markets on the technicalities of the BOJ's market operations, a
turnaround from the simple communication Kuroda preferred in
deploying his massive stimulus programme.
"It's challenging," said another source familiar with the
BOJ's thinking. "It will be trial and error."
($1 = 101.4300 yen)
(Additional reporting by Stanley White, Tetsushi Kajimoto,
Taiga Uranaka, Hideyuki Sano, Iga Daiki, Tomo Uetake and Lisa
Twaronite; Editing by Nachum Kaplan and Will Waterman)