The IMF has warned that an abrupt change in Japan’s ultra-loose monetary regime would have “meaningful spillover” effects on global financial markets, underscoring the need for the Bank of Japan to clearly communicate about its future policy.
In an interview, Gina Gopinath, the IMF’s first deputy managing director, called on the BoJ to take a flexible approach to controlling yields on government bonds as she warned of “significant upside risks” to inflation in the near term.
She added that Asia’s most advanced economy was at “a delicate juncture”. The BoJ, which will have a new governor in April, has come under increasing market pressure to shift away from its long-standing easing measures as Japan’s core inflation rate has risen to a 41-year high of 4 per cent. It faces the challenge of maintaining its accommodative monetary stance to achieve its inflation target while avoiding overshooting and turmoil in currency and bond markets.
“We still believe that it’s important for monetary policy to remain highly accommodative at this point. Yield curve control is a part of that toolkit,” Gopinath said during her visit to assess Japan’s economy.
“In the near term, we see significant upside risks to inflation. The increase in flexibility [in managing the yield curve] would help.”
The central bank slightly raised the cap on yields on 10-year Japanese government bonds in December, but it has made no further changes to its massive easing measures, arguing that price increases have not led to a rise in wages that would enable it to durably achieve its 2 per cent inflation target.
The IMF suggested the BoJ could consider three options to allow flexibility in long-term JGB yields: widen the 10-year band around the yield target and/or raise the 10-year target; shorten the yield curve target; or shift to a quantity target of JGB purchases.
“In the scenario that significant upside inflation risks materialise, monetary stimulus withdrawal will have to be much stronger,” it said in a statement.
Longer term, however, the IMF expects Japan’s core inflation, which excludes volatile food prices, to peak in the first quarter of this year and gradually decline to below 2 per cent by the end of 2024. It expects growth of 1.8 per cent in 2023 to slow to 0.9 per cent in 2024.
“We still believe that there are not enough signs that this will lead to inflation being durably at the 2 per cent target,” Gopinath said.
In December, the BoJ stunned investors by announcing it would allow 10-year government bond yields to fluctuate by 0.5 percentage points above or below its target of zero, replacing the previous band of 0.25 points. Last week, it introduced an expanded programme of loans to banks to stabilise the yield curve.
During a policy meeting last week, BoJ board members also said the central bank needed to continue with its current YCC policy, noting that it would take time to sustainably achieve its inflation target.
“The bank should carefully explain that it needs to continue with monetary easing, that its accommodative policy stance has not been changed, and that it will take time to achieve the price stability target of 2 per cent in a sustainable and stable manner because wage increases have not yet become full-fledged,” board members said according to a summary of opinions at the meeting released on Thursday.