The Bank of Japan will consider making negative interest rates the centrepiece of future monetary easing by shifting its prime policy target to interest rates from base money at its review next week, sources familiar with its thinking say. The change would underscore growing concerns in the central bank and financial markets over the limits to the BoJ's economic stimulus efforts, as more than three years of aggressive bond buying is draining market liquidity.
It would also be a shift away from the BoJ's unique monetary experiment that attempted to crush yields across the curve and try to convince the public that its massive money printing will boost economic activity and prices. "Among the BoJ's policy tools, the priority will likely shift more towards interest rates and away from huge bond purchases," said one of the sources on condition of anonymity.
The Nikkei reported earlier on Wednesday that the BoJ will put more emphasis on negative rates as a tool for future easing. The BoJ is unlikely to abandon its current base money target, which is the amount of money it commits to print each year, or adopt an explicit cap on long-term rates, they said.
Still, by shifting its policy focus to negative rates, the BoJ hopes to dispel growing market views that the unpopularity of negative rates among the public would discourage it to cut rates, even if it would arrest unwelcome rises in the yen. A prolonged period of indecision by the Federal Reserve could undermine the dollar and push up the yen, which has already surged nearly 17 percent so far this year, pressuring Japan's export machine.
There is no consensus in the BoJ yet on whether to deepen negative rates at the September 20-21 meeting, when it conducts the comprehensive assessment of its policies, the sources said. That decision will depend on yen moves and whether the board members feel that doing so would be necessary to reinforce the bank's commitment to achieving its inflation target, they said.
Most BoJ board members prefer such a modest fine-tuning of the current policy framework. But with markets increasingly expecting some form of easing at the review, more radical options are not off the table, such as ditching setting an explicit cap on bond yields, they said.
The BoJ shocked markets and the government in January by adding negative rates to its massive asset-buying programme launched in 2013. Under that scheme, it has pledged to increase base money at an annual pace of 80 trillion yen ($777 billion) via purchases of bonds and risky assets. Many BoJ officials have grown doubtful about how much effect increasing base money has had in heightening inflation expectations. But they are equally wary of entirely abandoning the base money target, the bank's prime policy target, for fear of triggering market fears it will taper its asset buying.
Policymakers got a taste of how markets might react to that this week as investors dumped longer-dated bonds on fears the BoJ will slow the pace of its purchases. The 30-year JGB yield rose to a six-month high while the 20-year JGB yield rose to 0.495 percent, a level last seen in March.
The BoJ will thus maintain the base money target and the pace of asset purchases. But it will consider changing its prime policy target to the 0.1 percent negative rate it now charges for a portion of excess reserves financial institutions park with the bank, the sources said. "The base money target does not need to be removed because there is indeed some positive effects to it," said a source familiar with the BoJ's thinking.
"But it's feasible to focus more on keeping short-term interest rates low," the source said. The BoJ says it has three easing tools: buying more bonds, buying more risky assets and deepening negative rates. At next week's review, it will likely signal markets that cutting rates would be the more preferred future option as it directly pushes down short- to medium-term rates that have the biggest impact on corporate borrowing costs.
The BoJ will also consider reducing purchases of super-long government bonds to give financial institutions such as insurers and pension funds a better environment for earning returns, the sources said. Purchases of shorter-term bonds could be increased to compensate, so that the overall bond buying amount would not decrease, they said. To justify concentrating its purchases on short-term debt, the BoJ will issue an analysis showing that lowering yields of up to 10 years has a bigger positive impact on the economy than pushing down longer-dated yields, sources said.
The BoJ is likely to maintain its pledge to hit its 2 percent inflation target "at the earliest date possible." But with over three years having passed since deploying its asset-buying programme, the central bank will abandon the two-year timeframe it set for achieving the price goal, they said. With consumer inflation stuck near zero, the BoJ has been forced to repeatedly push back the target, most recently to the March 2018 end of fiscal 2017.
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