September 27, 2013 / 6:52 AM / in 4 years

BOJ FOCUS-BOJ's takeaway from Fed bungle: keep the message simple

By Leika Kihara
    TOKYO, Sept 27 (Reuters) - The U.S. Federal Reserve's
surprise decision not to start tapering its massive stimulus
convinced the Bank of Japan about one thing - the need to keep
market expectations anchored with a simple, clear message.
    BOJ policymakers have sprung into action since last week's
Fed gathering with the most explicit explanations to date of how
the central bank will measure the success of its own policy -
turning years of deflation into 2 percent inflation.
    In so doing, they have indicated the central bank's economic
stimulus could remain in place after two years, the timeframe it
gave in April for getting to 2 percent inflation, and so
implying that it is a long way from even considering its own
exit strategy.
    They want to avoid the sort of market volatility triggered
by the Fed, which for months had flagged it could rein in its
economic stimulus before the end of the year, prompting markets
to expect an announcement at last week's meeting. Fed Chairman
Ben Bernanke had suggested the stimulus could stop by the middle
of 2014.
    People familiar with BOJ thinking say the central bank wants
to pre-empt questions about its policy following the Fed's
meeting. They think the Fed had been too specific in identifying
the conditions that would trigger a tapering of its stimulus and
in the end that made it difficult to avoid causing a market
upset.
    "Offering a lot of guidance doesn't necessarily heighten
transparency on monetary policy," said one of the officials
familiar with the BOJ's thinking.
    The officials declined to be identified because they are not
authorised to speak publicly.
 
 
    
    Japan is years away from engineering an exit from its own
huge stimulus. But since it is following similar policies to the
Fed it had more than a passing interest in the U.S. central
bank's meeting. The Fed injects $85 billion into its economy
each month, while the BOJ injects about 7 trillion yen ($71
billion) - policies known as quantitative easing.
    
    TIMING
    The Fed's decision to delay the start of tapering surprised
not only markets but many BOJ officials. The Fed's forward
guidance had heightened, rather than diminished, confusion over
the course of policy, some said.
    In their eyes, the more the Fed offered guidance on the
potential timing of policy turns, the less leeway the U.S.
central bank left itself to make adjustments later if economic
conditions changed.
    "Don't talk too much about the policy outlook, particularly
about the timing of an exit," said a source with direct
knowledge of the central bank's thinking. "That may be the
takeaway for the BOJ from what happened last week."
    The big fear for the BOJ is that markets start to factor in
a change in its policy too soon, as they did with the Fed.
    "The Fed was only trying to scale back stimulus, not tighten
policy. Still, markets got ahead of themselves and long-term
rates shot up more than expected," BOJ board member Takahide
Kiuchi said hours after the Fed's decision.
    To try to avoid any misunderstanding about BOJ policy, some
board members moved quickly to spell out what the BOJ's end game
looks like.
    Although the BOJ launched its massive stimulus campaign in
April, it had been largely coy about describing the conditions
that would signify it had met its policy goal of 2 percent
inflation, raising questions in markets.
    Would it rein in stimulus even before 2 percent inflation is
reached if it felt economic momentum was such that 2 percent
inflation was certain? Or would it maintain stimulus even after
data showed inflation had reached 2 percent in order to ensure
the rate was maintained?
    In a speech delivered two days after the Fed decision, BOJ
Governor Haruhiko Kuroda suggested simply reaching 2 percent
would not be enough. Instead, the inflation level would have to
be inbuilt into Japanese expectations.
    "To use the metaphor of the anchor, the aim is to set the 2
percent anchor deeply in people's understanding and make the
observed inflation rate hover around that anchor," Kuroda said
in a speech. "That is what the BOJ means when it says 'maintain
2 percent in a stable manner'."
    And in the most direct comments by a BOJ policymaker that
stimulus could continue beyond the two-year timeframe set for
reaching 2 percent inflation, former IMF economist Sayuri Shirai
said a key message of the central bank is that it will not
consider an exit unless the inflation target is achieved.
    Such guidance "warrants any necessary actions by the bank
beyond the two-year horizon," she said.
    "(The) guidance plays an essential role in reducing
volatility of long-term interest rates, and in preventing them
from overshooting," Shirai said.
    
    ANCHORED
    The people familiar with BOJ thinking said it was crucial
for the central bank to keep inflation expectations
well-anchored because any sudden spike in bond yields will
inflict far greater damage on the economy than in other
countries because of the need to fund Japan's huge public debt.
    At more than twice the size of its $5 trillion economy, the
debt is the heaviest burden among industrialised countries. So
it is critical to curb any unwelcome spike in bond yields to
keep borrowing levels manageable.
    To be sure, the BOJ can keep its message simple for now
because its policy course is nowhere near a turning point. In
fact, markets doubt the BOJ can boost inflation to 2 percent in
two years even though core consumer prices are rising at 0.8
percent a year. Two-year bonds barely yield 0.1
percent and 10-year bond yields are only 0.6
percent.
    But BOJ policies will face much deeper scrutiny when
inflation does finally approach 2 percent, much like it did
under its previous quantitative easing programme in 2001-2006,
when it had pledged to maintain stimulus until consumer prices
were "stably above zero".
    As early as 2003, bond yields jumped as an improvement in
the economy sparked expectations policy may be close to a
turning point. The BOJ spent the remaining years of its
quantitative easing programme reminding markets its ultra-loose
policy would remain in place.
    "Long-term rates may rise more than expected if price rises
gather pace. When that happens, the BOJ may need to fine tune
its message on an exit," a source familiar with its thinking
said.
    A former BOJ policymaker, who was on the board during the
previous quantitative easing campaign, said Bernanke was trapped
because the Fed was too specific in its timeline.
    "You can plan early and lay out scenarios for tapering. But
you don't have to share all that information with markets, when
you know things may not go as initially planned," this person,
who has close contacts with the current members of the board,
said.
 ($1=98.9550 yen)

 (Editing by Neil Fullick)

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