It looks like BoJ Governor, Haruhiko Kuroda’s, minions are getting out and about to brief the financial news services that the biggest stimulator of all the central banks might reduce stimulus earlier than expected. The recipient of the unofficial briefings by BoJ officials is Reuters, which has this to say.
The Bank of Japan is dropping subtle, yet intentional, hints that it could edge away from crisis-mode stimulus earlier than expected, through a future hike in its yield target, according to people familiar with the central bank’s thinking.
With inflation still way below its 2 percent target, the BOJ sees no immediate need to withdraw stimulus, and regards weak price growth as its most pressing policy challenge. But bank officials are now more vocal on the rising cost of prolonged easing, such as the hit to bank margins – a sign that their next move would be to roll back stimulus rather than expand it, the people said.
It seems that BoJ has been sending signals – in particular by referring to the “reversal rate” – but some people weren’t paying attention.
The first sign of change came in Nagoya on Nov. 6, when BOJ Governor Haruhiko Kuroda – whose current term ends in April – said he was “mindful” of the risk prolonged easing could hurt banks’ appetite to lend. Days later, board member Yukitoshi Funo said the BOJ must be vigilant to the cost of easing. The most striking warning came from Kuroda last week, when he referred to a “reversal rate” – the level where rate cuts by a central bank hurt, not help, the economy by damaging banks and discouraging lending.
Kuroda gave a speech with the catchy title “Quantitative and Qualitative Monetary Easing and Economic Theory” at the University of Zurich on 13 November 2017. During the speech, in a section “Determining the Optimal Yield Curve”, he specifically referred to the reversal rate.
Another issue that has recently gained attention with regard to the impact on the functioning of financial intermediation is the “reversal rate.” This refers to the possibility that if the central bank lowers interest rates too far, the banking sector’s capital constraint tightens through the decline in net interest margins, impairing financial institutions’ intermediation function, so that the effects of monetary easing on the economy reverses and becomes contractionary. In Japan’s case, financial institutions have a solid capital base and credit costs have fallen sharply, so that at present their financial intermediation function is not impaired. However, because the impact of the low interest rate environment on financial institutions’ soundness is cumulative, the Bank will continue to pay attention to this risk as well…Taking also various kinds of qualitative information into account, the Bank of Japan will continue to pursue the shape of the yield curve that is deemed most appropriate in order to maintain the momentum toward the 2 percent price stability target.
Okay, so we know Kuroda is focusing on the impact of the so-called reversal rate in the context of the yield curve. The unnamed BoJ officials spell it out to Reuters.
The most likely first step – albeit some time away – would be to allow long-term rates to rise more, reflecting improvements in the economy, they said. “The change in tone doesn’t have immediate policy implications, but it’s probably intentional,” one of the people said. “The BOJ wants to make its policy framework more sustainable,” said another. “Allowing longer-term rates to rise more would give banks some breathing space.”
We really should have paid more attention because Reuters implies (kind of) that referencing the reversal rate is central bank code for “we are preparing to reduce stimulus”…and the BoJ does like to drop hints.
European Central Bank (ECB) executive board member Benoit Coeure referred to the reversal rate in July last year in discussing when further rate cuts could become counter-productive. Five months later, the ECB decided to cut monthly asset purchases from 2017. The BOJ also has a history of dropping early hints of a future policy shift. Roughly a year before adopting its yield curve control (YCC) policy, the BOJ published a research paper analysing the feasibility of the idea.
In his speech “Assessing the implications of negative interest rates” at the Yale Financial Crisis Forum, Coeure noted.
it has been suggested that at some point the level of rates can become low to the extent that the detrimental effects on the banking sector outweigh the benefits of lower rates. In a recent paper, Brunnermeier and Koby refer to this rate as the “reversal rate”. At the reversal rate, bank profitability will fall, reducing capital generation via retained earnings, which is an important source of capital accumulation, and thereby eventually restricting lending.
Surpassing itself, Reuters “found” a BoJ board member, a former one anyway, who will speak on the record.
“Reversal rate is a pretty shocking word to come out of the mouth of a BOJ governor. It’s unthinkable the BOJ would insert it in Kuroda’s speech without any policy intention,” said Takahide Kiuchi, who was a BOJ board member until July.
The BOJ may allow long-term rates to rise more by shifting its long-term rate target to five-year yields from 10-year yields around the first quarter of next year, Kiuchi said. “The BOJ could put a positive spin on the move by saying it can more effectively reflate growth by keeping short-term borrowing costs low while allowing longer yields to rise.”
So there we have it…the BoJ is preparing to pull back on its obscene level of stimulus. Some time in the first quarter of 2018, or just after, the bank will adjust its Yield Curve Control (YCCC) policy, allowing the 10-year JGB yield to rise above the current zero percent target. Reuters explains.
The shift in communication comes as the U.S. Federal Reserve and ECB head for an exit from ultra-loose policy, and suggests the BOJ could follow suit sooner than expected. A majority of economists polled by Reuters before Kuroda’s latest comments expect the BOJ’s next move to be a withdrawal of stimulus – but not until later next year or beyond.
Just to make it really clear what’s happening, this was Reuters’ parting shot.
“It’s important the BOJ prepares markets in advance with careful communication,” said a third person familiar with the bank’s thinking.
Is this why the Yen is strengthening?