By Leika Kihara and Tetsushi Kajimoto
TOKYO (Reuters) – New Bank of Japan (BOJ) Governor Kazuo Ueda said on Friday the central bank must maintain ultra-low interest rates to support the fragile economy and warned of the dangers of responding to cost-driven inflation with a monetary tightening.
While signaling an opportunity to tweak the BOJ’s Bond Yield Curve Control (YCC) in the future, Ueda said the bank needs to work out the right timing and means to do so, a sign the new boss will be in no rush to complete the Controversy to revise policy.
Speaking to lawmakers, Ueda said the recent surge in inflation is mainly being driven by rising commodity import costs rather than strong demand, adding that the outlook for Japan’s economy is highly uncertain.
Global bond yields fell and Japanese equities rallied as Ueda’s emphasis on patience and policy continuity dampened some market expectations that he might seek to quickly move away from the extreme monetary stimulus of his dovish predecessor Haruhiko Kuroda.
“It is common to react pre-emptively to demand-driven inflation but not to react immediately to supply-driven inflation,” Ueda said at a confirmation hearing in the House of Commons.
“Japan’s trend inflation is likely to rise gradually. But it will take time for inflation to reach the BOJ’s 2% target in a sustainable and stable manner,” he said.
“It is true that various side effects result from the stimulus. But the BOJ’s current policies are a necessary and appropriate means of achieving 2% inflation.”
The yen was volatile, swinging between gains and losses against the dollar as investors analyzed Ueda’s comments. It was last up 0.03% at 134.76 per dollar.
Earlier this month, the government nominated the 71-year-old academic to be its choice as the next central bank governor in a surprise election that markets initially saw as increasing the chance of an end to unpopular YCC policies.
With inflation exceeding the BOJ’s target, Ueda faces the tricky task of phasing out YCC, which has been publicly criticized for distorting market functions and narrowing banks’ margins.
“There are different ways YCC could look in the future,” he said, adding that there are side effects from the policy, such as a deterioration in market function.
But he said the BOJ must first monitor whether the actions it took in December, such as widening the band around its yield target, would help mitigate the side effects.
Ueda’s warning of changing course too soon was echoed by Shinichi Uchida, a career central banker and the government’s deputy BOJ gubernatorial candidate, who said it was inappropriate to tweak ultra-loose policy just to deal with its side effects.
“The BOJ’s current interest rate target levels, including the negative short-term interest rate, are reasonable. If Japan can forecast 2% inflation, the target levels could be reviewed. But that won’t happen immediately,” Uchida told lawmakers in the same confirmation hearing.
POSSIBILITIES
Targeting shorter-dated bond yields instead of the current 10-year yield could be one of the options, although there are various other ideas should the BOJ tweak YCC going forward, Ueda said.
“If trend inflation picks up significantly and a sustainable achievement of the BOJ’s 2% target is on the horizon, the central bank needs to consider normalizing monetary policy,” Ueda said.
When stimulus expires, the BOJ would hike interest rates on financial institutions’ reserves parked at the central bank instead of selling bonds, Ueda said.
Subject to parliamentary approval, Ueda will succeed incumbent Kuroda, whose second five-year term ends on April 8.
“Overall, Ueda is working hard to present itself as a continuity provider — at least initially,” said Sean Callow, senior currency strategist at Westpac. “Now is not the time to put your own stamp on politics; that’s not why the government chose him.”
The upper house of parliament will hold the hearing on Monday to confirm Ueda, which is due for the two MPs on Tuesday.
The nominations require the approval of both houses of parliament, which are effectively a done deal as the governing coalition holds a solid majority in both.
Under YCC, the BOJ keeps short-term interest rates at -0.1% and the 10-year bond yield at around 0% as part of efforts to sustain its 2% inflation target.
Faced with pressure from rising global interest rates, the BOJ was forced to raise the implied cap on its 10-year yield target from 0.25% to 0.5% in December – a move that fueled market expectations of an imminent adjustment by YCC.
(Reporting by Leika Kihara; Additional reporting by Tom Westbrook in Singapore; Editing by Sam Holmes)
