BOJ may abandon 10-year bond yield cap early next year

BOJ may abandon 10-year bond yield cap early next year

Takeo Hoshi, an academic with close ties to incumbent central bank policymakers, said the Bank of Japan may abandon its 10 year bond yield cap early next year because of growing prospects that inflation and wages will overshoot expectations.

The BOJ must maintain ultra-loose policy for the time to convince the public that it is serious about reflating the economy long enough to generate sustained inflation, said Hoshi, an economics professor at the University of Tokyo.

But the central bank must be vigilant against the risk of inflation well exceeding its expectations, as intensifying labour shortages lift wages not only for part-time but permanent workers, he told Reuters in an interview on Monday.

With inflation expectations already sufficiently high, core consumer inflation could surpass the BOJ's 2 per cent target next fiscal year, and open scope for the central bank to abandon its 0 per cent target for the 10 year bond yield, Hoshi said.

Prices didn't rise much in Japan in the past, but that's changing, Hoshi said. Japan might enter an era of high inflation. The possibility of inflation accelerating more than expected is something that the BOJ must worry about. Hoshi was a panelist at the BOJ's workshop on November 25 and spoke about Japan's wage dynamics, a member of various government committees and an expert on macroeconomic policy.

Under yield curve control YCC the BOJ guides short-term interest rates at 0.1 per cent and pledges to guide the 10 year bond yield around 0 per cent. As part of an effort to achieve 2 per cent inflation, it goesbbles up government bonds and risky assets.

The central bank has been forced to offer unlimited amounts of 10 year government bonds in order to defend the yield target, a move criticised by investors for draining bond market liquidity and distorting the shape of the yield curve.

He said that if the BOJ were to normalise monetary policy, it will do so in several stages starting with the removal of the 10 year yield target that is distorting the shape of the yield curve.

The central bank will reduce the size of its balance sheet by slowing or ending asset purchases before moving onto raising short-term interest rates, Hoshi said.

If the pressure on global interest rates persists, the BOJ could be forced to abandon YCC as early as next year, he added.

The BOJ has been an outlier amid a global wave of central banks tightening monetary policy, even as rising raw material prices push core consumer inflation above its 2 per cent target.

The BOJ Governor Haruhiko Kuroda has ruled out withdrawing the stimulus unless recent cost-push inflation is accompanied by higher wages growth, which remains stubbornly low.