BOJ takes steps to make policy flexible but vows to keep rates low

The Bank of Japan took measures to make its massive stimulus programme more flexible and pledged to keep interest rates low for the time being on Tuesday, reflecting its forecast that it would take time for inflation to hit its 2 percent target.

The decision underscored the challenges the BOJ faces as stubbornly weak inflation forces it to maintain a massive stimulus programme despite the rising costs of prolonged easing.

The changes indicate that while Governor Haruhiko Kuroda plans on keeping radical stimulus programme in place for now, he is looking at the impact the policies are having on other parts of the economy, such as the financial markets and banking system.

At a two-day rate review that ended on Tuesday, the BOJ decided to maintain its short-term interest rate target at minus 0.1 percent and a pledge to guide 10-year government bond yields around zero percent by a 7-2 vote.

But the bank said it would allow long-term rates to fluctuate depending on economic and price developments, and conduct its asset purchases more flexibly.

"The BOJ will purchase government bonds so 10-year yields remain at around zero percent. While doing so, the yields may move upward and downward to some extent mainly depending on economic and price developments," the central bank said in a statement announcing the policy decision.

The central bank also said that it will conduct bond purchases in a "flexible manner" in meeting a loose pledge to increase its bond holdings by around 80 trillion yen per year.

Japanese shares pared losses while the yen fell and yields on Japanese and U.S. bonds declined on Tuesday after the BOJ decision, which stayed away from making drastic changes to its accommodative policy.

The Nikkei turned positive while the dollar gained 0.25 percent against the yen to 111.33 yen.

In an apparent move to keep yields from rising on expectations of future policy normalisation, the BOJ adopted forward guidance on policy rates that pledges to keep rates low for the time being.

"The BOJ intends to maintain current extremely low levels of short- and long-term rates for an extended period of time," taking into account uncertainties over the outlook including the effect on the economy of next year's scheduled sales tax hike, the bank said in the statement.

The BOJ also said it will make tweaks to the way it buys assets, such as raising the composition of Topix-indexed exchange traded funds (ETF) to ease distortions created by the central bank's purchases of ETFs.

In a quarterly review of its projections also released on Tuesday, the BOJ trimmed its price forecasts and conceded inflation could fall short of its target for three more years.

The central bank has failed to break Japan's entrenched deflationary mindset despite years of heavy money printing, with stubbornly soft inflation sapping its ammunition and global trade woes clouding the outlook for an export-reliant economy.

But there is uncertainty over how long it can sustain the current ultra-easy policy given the strain near-zero rates are inflicting on Japanese banks and the bond market.

Aside from its yield targets, the BOJ floods markets with cash by buying risky assets such as exchange-traded funds (ETF) and corporate bonds. It also keeps a loose pledge to increase its government bond holdings by 80 trillion yen ($720.79 billion) per year.