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Bank of Japan policy and long-term bond yields

A speech by Bank of Japan’s Takehiro Sato underscores that stabilizing long-term JGB yields has become a particular focus in the context of “Qualitative and Quantitative Easing”. This reflects the vulnerability of the country’s banks to higher yields (view post here), and the huge debt stock of the government. The Bank reckons that the sheer size and flexibility in its bond purchase program are at present sufficient to contain yield volatility and levels.

Takehiro Sato: Recent economic and financial developments, and monetary policy 
Speech at a meeting with business leaders, Fukushima, 22 July 2013.  

The below are excerpts from the speech. Cursive text and emphasis have been added. 
“At the Monetary Policy Meeting (MPM) held on April 3 and 4, 2013, the Bank introduced quantitative and qualitative monetary easing (QQE). This policy aims to achieve the “price stability target” of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years. To achieve this, the Bank decided on new monetary easing measures.” (view post here).

The problem

“It should be noted that QQE has contradictory, two-sided policy effects on the JGB market. Massive bond purchases by the Bank lower the risk premiums in the JGB market, and this contains nominal interest rates; at the same time, once the policy effect materializes, the market’s anticipation of a recovery in economic activity and prices exerts upward pressure on nominal interest rates. After the introduction of QQE, interest rates fluctuated due to these two contradictory factors, and the volatility in the JGB market rose as a result. Such high volatility, if it is prolonged, tends to prompt market participants to sell bonds for the purpose of risk management, and heavy bond sales could cause an unnecessary rise in interest rates.”

“Some reports – such as the Consumer Confidence Survey released by the Cabinet Office, the Opinion Survey on the General Public’s Views and Behavior released by the Bank, and surveys conducted on economists and market participants – already suggest a rise in inflation expectations, although it is hard to gauge the extent to which this is caused by the scheduled consumption tax rate hikes. The Bank expects a mechanism of a feedback loop between inflation expectations and the actual inflation rate – in which a rise in inflation expectations causes a rise in actual inflation and vice versa – to operate and medium-term inflation expectations to rise accordingly.”

The policy approach

“Given the heightened volatility in the JGB market, at the May MPM the Policy Board members discussed measures to stabilize long-term interest rates, and confirmed that for JGB purchases it was important for the Bank to conduct operations flexibly. At the end of May, the Bank clearly showed that it would conduct operations flexibly, for example by adjusting as necessary the parameters of its JGB purchases, such as frequency and allocation of purchase amounts by maturity.”

“The Policy Board members concluded [at the June 2013 policy meeting] that it was not necessary at that time for the Bank to extend the maximum duration of loans provided through its funds-supplying operations against pooled collateral, because (1) the effect of compressing risk premiums driven by the Bank’s massive JGB purchases was likely to strengthen steadily, and (2) flexible conduct of market operations was sufficiently ensured under the current guideline for the operations to contain the volatility. In other words, the current policy guideline allows a range of “about six to eight years” for the average remaining maturity of the Bank’s JGB purchases. By utilizing this guideline, it would be possible to stabilize the entire yield curve by purchasing JGBs with a maturity of one to five years more intensively. As the policy guideline allows a range of ‘about six to eight years’, I see no need for concern even if the actual remaining maturity of JGB purchases temporarily falls short of six years. ”

“The Bank, however, does not completely exclude the possibility of introducing [extended-duration fund supplying] operations, since they could be an effective tool for stabilizing the market.”

The judgment so far

“In the JGB market, long-term interest rates rose with some volatility and these developments drew public attention…When Japanese long-term interest rates rose with volatility after the policy change in April, some regarded the new policy as a failure. But…market developments since end-2012 show that there has been a positive correlation between the JGB and stock markets – long-term interest rates rose when stock prices surged and long-term interest rates plunged when stock prices dropped. It can be added that Japanese long-term interest rates have been substantially contained despite the rising stock prices and fluctuations in foreign exchange rates since end-2012, given the effects of the increase in the Bank’s purchases of JGBs. Moreover, the recent stability in the JGB market compares favorably with the large fluctuations in the U.S. bond market since the end of May.”


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