The Battle Over the Japanese 10-year Bond Yield

by: Gary Dorsch

The Bank of Japan said on Feb 23rd that it had entered a critical phase in deciding when to start dismantling its ultra-loose monetary policy but had not yet decided on the details of a new policy framework.

BOJ Governor Toshihiko Fukui, however, reassured markets that it would keep rates pinned near zero percent even after ending "quantitative easing", the five-year-old policy under which the BOJ floods the financial system with money to spur business activity. "Japan's economy is in a firm recovery and I am confident it will continue on a long-lasting recovery," Fukui told a parliamentary committee in a hearing on the BOJ's twice-annual report to parliament. "The CPI should show a relatively clear uptrend from January. Therefore, it is becoming ever more crucial than before to assess the rate of year-on-year gains in core CPI," he said.

Fukui reassured markets, however, that the BOJ would not immediately start tightening credit even as it starts drawing down its level of excess funds. As part of quantitative easing, the BOJ targets the amount of funds that banks keep in their current account reserves at the central bank at 30-35 trillion yen ($253-296 billion), around five to six times legally required level. "While the current account reserves exceed the level required, I believe short-term rates will, apart from some fluctuation, basically be at zero. We should continue providing a very accommodative credit environment."

He also said the BOJ would gradually raise rates to neutral levels after a period of "extremely low rates". BOJ Deputy Governor Toshiro Muto told the same committee that the end of the current policy "will not mean an immediate monetary tightening". Fukui added that the BOJ would watch to ensure that long-term bond yields are stable and reflect economic fundamentals. "In order to improve the real, potential growth rate of Japan´s economy, companies need to make long-term investments to continue innovation. The BOJ is greatly interested in ensuring that long-term yields are in line with the economy and prices."

Vice Finance Minister Koichi Hosokawa said on Feb 24th that Japan's economy is still stuck in mild deflation despite comments by the Bank of Japan governor that consumer prices are starting to recover. "I think deflation continues in a mild form," when asked about BOJ Governor Toshihiko Fukui's comments in parliament earlier in the day. "We must look at indicators carefully as we make assessments," he said.