Q&A: BOJ may begin policy normalization in 2018 - ex board member Shirai

MUMBAI (Reuters) - The Bank of Japan’s recent decision to make its policy more flexible was “more than just a tweak” and it could take further steps to normalize policy this year, former board member Sayuri Shirai told the Reuters Global Markets Forum on Wednesday.

“The intention is a move toward normalization,” said Shirai, who left the BOJ in March 2016 and is now a visiting researcher with the Asian Development Bank.

Following are edited excerpts from the conversation in the online chat room:

Question: How significant is the BOJ’s latest decision to make its policy more flexible, and how will it affect future monetary policy?

Answer: It is important. It was more than just a tweak. The intention is a move toward normalization.

The BOJ faces the limit. The BOJ is already reducing the annual pact of purchases from September 2016 when yield curve control (YCC) was introduced. The BOJ is now buying only less than 50 trillion yen annually over the past four months.

There is strong criticism from insurance firms and banks on YCC. This is why the BOJ expanded the 10-year target from 0.1 percent to 0.2 percent. This July adjustment did not steepen the yield curve much mainly because the BOJ emphasized that the 10-year target remains the same zero percent. The target range to 0.2 percent was not mentioned in the statement. Only BOJ Governor Haruhiko Kuroda said it lightly in the press conference. So the market did not fully understand BOJ’s motivation.

The BOJ will reduce super-long JGB purchases to steepen the yield curve. The July adjustment made only a minor increase on super-long maturity. Insurance firms are already complaining. Since YCC was introduced, there is a gap between what the statement says and the actual practices (of the BOJ).

All the adjustments suggesting that the BOJ wants to reduce JGB and ETF purchases and want to raise 10-year target because they are concerned about financial system stability. But Kuroda did not admit it at the press conference. He said that the motivation of the adjustment was to improve JGB market function. He denied that the adjustment was for financial institutions.

Why is the BOJ not so honest about it? Because I believe that the BOJ is afraid of further demand for interest rate hikes from financial institutions.

Q: By when do you see normalization coming?

A: I think the next move may come in the second half of 2018 if the U.S. economy, stock market and the dollar remain strong. If the BOJ cannot do that this October or January next year, it will be much harder to do it in 2019.

The biggest concern for the Japanese government is Japanese stock prices. So, the BOJ has to make sure that their next modest adjustment will not lower stock prices. That depends on U.S. financial markets, as also on Japanese firms’ profits. So far, profits remain okay.

Q: What is fair value for the yen? Is there any target that the BOJ has for it?

A: I think that the fair value of yen against dollar is around 100-105 yen. 110 is not, but it is only mildly undervalued. Look at the past five years under BOJ policy. Corporate profits are high partly due to yen’s depreciation and 2020 Olympic games. But consumption remains very weak. Most people do not feel that real wages increased because of higher imported prices.

Q: How much reduction in ETF purchases can be expected, and when?

A: The BOJ will be very careful. They will try to reduce slightly. The ideal is to reduce ETF purchases from 6 trillion yen toward zero. But this may be a very difficult thing since the market has already incorporated BOJ intervention. Hopefully to 5 trillion yen for the time being.

No timeline, it will depend on the market conditions. Now the U.S. stock market is becoming stronger. The dollar may strengthen. Japanese corporate profits are still good. It is good to do it now. But at the same time, the BOJ and government may worry that U.S. President Donald Trump may start to criticize BOJ policy, which may lead to the yen’s appreciation and stock price fall. So the BOJ may try to reduce ETF purchases only very, very slightly.

Q: How do you see the BOJ using its new forward guidance in communicating with markets?

A: The forward guidance does not have any substance. But it tried to imply that the BOJ is concerned about the adverse impact of the consumption tax hike of October 2019. But the BOJ did not make clear about how they will target interest rates and how long they will maintain.

They cannot communicate more openly in the future because they know the 2 percent (inflation) target is not easy to achieve. But they cannot give it up since it is related to the government goal. So they want to be flexible and vague. The forward guidance is just suggesting that the BOJ will continue to provide sufficient accommodation. Nothing more. The guidance is very different from the ECB’s.

Q: The 2 percent inflation target seems unachievable in these circumstances. Do you see the BOJ revising the target downwards?

A: The BOJ is better off not to drop the 2 percent target. My suggestion is to introduce plus and minus 1 percent to the 2 percent target (1 percent-3 percent). The public will accept this target since 1 percent inflation is okay. The BOJ does not need to abandon its 2 percent target because that will shock the central bank circle and damage the market.

(This interview was conducted in the Reuters Global Markets Forum, a chat room hosted on the Eikon platform.)