One of central banking’s most aggressive easers—the Bank of Japan—may soon have to think about tightening for the first time since 2007.
The latest buzz in Japanese monetary-policy circles is that the BOJ may have to lift the 10-year government-bond target from a recently set zero.
It wouldn’t be the first to blink. On Thursday the European Central Bank, which like the BOJ has driven interest rates down and pumped cash into the economy with vast bond buying, announced that its continued easing would be combined with some tightening.
The changed view on BOJ policy is quite a turnaround. Just a few months back investors and economists world-wide were discussing what would be the next easing steps in the bank’s 15-year fight to boost the economy and produce inflation. More certainly seems needed: Japan’s economy grew more slowly than expected in the latest quarter and prices are falling.
So why switch gears now? Blame Donald Trump.
The U.S. dollar and Treasury yields have been climbing since soon after Mr. Trump was elected president on Nov. 8, triggered by expectations that his policies would boost U.S. growth, inflation and interest rates.
So far, that has been good for Japan, where the weaker yen is brightening exporters’ prospects, helping send Tokyo stocks to 11-month highs. A weaker yen bolsters their bottom lines by making their products cheaper overseas and inflating the value of repatriated income. As of Friday, one dollar buys ¥114.50, 9.6% more than the day before the U.S. election.
While that may be fine as far as it goes, some central-bank watchers say the BOJ’s latest easing policy raises the risk of far greater, and potentially damaging, depreciation.
The policy, announced in September, aims to keep interest rates ultra-low without gutting the financial system. The BOJ effectively pinned Japan’s yield curve in place, holding short-term rates at minus 0.1% and the yield on 10-year government bonds at around zero.
As yields rise around the world—led by the U.S., whose Federal Reserve is expected to raise rates on Dec. 14—the gap between Japan and other markets widens. That draws money out of Japan as investors search for better returns, which puts further pressure on the yen.
Since U.S. Election Day, U.S. 10-year Treasury yields have risen to 2.426% from 1.862%, far outstripping the Japanese benchmark bond’s rise to 0.056% from minus 0.064%. Bond yields rise when prices fall.
If the U.S. 10-year yield climbs to 3% or higher next year, as some economists think it could, the BOJ may be forced to raise its yield target in response, even if it hasn’t achieved its policy goal of 2% inflation. The pressure to raise the target could be especially intense if the yen weakens to levels like ¥130 to the dollar.
That sounds all right to believers in Japanese Prime Minister Shinzo Abe’s Abenomics plan to goose the economy with easy money.
A weaker yen could boost optimism and inflation expectations among Japanese companies, argues Abe adviser Etsuro Honda, making them more willing to invest and raise wages. If the result was increased upward pressure on bond yields, the “natural course of action” would be for the BOJ to raise the 10-year yield target a touch from zero, he said. Two months ago Mr. Honda was calling on the BOJ to lower its targets as an added jolt of easing.
For Abenomics skeptics, the yen’s deteriorating prospects ring alarm bells. BNP Paribas chief Japan economist Ryutaro Kono said in a recent note for clients that a fall to ¥115 to the dollar could upset consumers by raising the cost of living. When BOJ easing weakened the yen to ¥125 to the dollar from ¥110 between autumn 2014 and summer of 2015, it cast a chill over the economy as rising costs for imported food and necessities battered consumers while companies held back from raising wages.
Other Japanese economists say the BOJ may have to raise its bond-yield target just to give more breathing room to the country’s banks, whose profits are dwindling as their longer-term lending rates fall dangerously close to what they’re paying on deposits.
“It’s like they’re submerged under water and holding their breath,” said Kazuo Momma, a former BOJ executive director who is now executive economist at Mizuho Research Institute. “If this situation becomes protracted, they could drown.”
Ahead of a Dec. 19-20 policy meeting, some BOJ officials say they are puzzled by the talk about rate increases, since the Trump rally could still reverse and deflation remains entrenched.
“Is it a time to worry about ‘easing too much’?” asked one person close to the BOJ.