Shadow of deflation holds BOJ back despite US action
'Long road ahead' toward 2% inflation target, admits Kuroda
TOKYO -- Limp inflation has shackled Japan's central bank to maintaining its monetary easing policy, despite the ongoing economic recovery and a tailwind from the U.S. Federal Reserve's rate hike Wednesday.
The Bank of Japan's policy board decided Friday to maintain the existing quantitative and qualitative easing program, leaving policy unchanged for the ninth month running. "It will take time to shift away from deflationary mindsets," Gov. Haruhiko Kuroda said at a press conference.
The bank will continue steering short-term interest rates to -0.1% and long-term ones to around zero. Its economic outlook report echoed the previous assessment from April, saying Japan's economy "has been turning toward a moderate expansion." The meeting was largely uneventful, as most economists predicted.
Japan's economy "is likely to continue its moderate expansion," Kuroda said. The current recovery, begun in December 2012, has become Japan's third-longest in postwar history, beating the expansion seen during the asset-price bubble of the late 1980s and early 1990s. Demand has also climbed relative to supply, creating fertile ground for prices to rise.
Yet real inflation rates remain stalled around 0%. Many developed countries have hit the same predicament, where prices fail to rise even with an improved supply-demand gap, but Japan's weakness stands out. Businesses' efforts to raise prices have been lacking, and the economy has failed to rev up a virtuous cycle in which wage raises revive consumption, prompting price hikes, which lead to better earnings.
"There remains a long road ahead" toward the bank's goal of 2% inflation, Kuroda acknowledged at the conference.
The bank's hands are tied, however, since turning up the easing is not a viable option. The BOJ is still holding out hope of hitting its inflation target around fiscal 2018, and there are growing concerns about the potential side effects of prolonged easing. Some economists fear that the bank's financial health may deteriorate once it starts normalizing monetary policy, and have called for the BOJ to present its exit strategy.
Kuroda has rejected the call, saying that it "could end up bringing more confusion to the market" if the bank showed its hands and had to change some plans later. Some say the bank ought to reduce excessive easing, but he counters that the importance of staving off fears of a return to deflation and meeting the price stability target far outweighs the problem of easing lasting longer.
On top of a new key rate hike, the Fed announced Wednesday it would maintain its pace of three rate raises a year, and that it would start paring back its massive assets this year. If this tightening causes U.S. interest rates to climb, the widening rate gap with Japan will cause the yen to soften against the dollar, improving earnings for Japanese businesses. It would make it easier for the BOJ to start normalizing its monetary policy.
Going back through history, the BOJ has tended to follow the Fed's benchmark rate hikes with its own monetary tightening. One official at the Japanese central bank said the hope is that the U.S. "would somehow keep raising rates continuously." If the U.S. economy were in a position to absorb rate hikes, it would be a boon to Japanese exports, and provide a tailwind toward tightening for the BOJ.
But even in the U.S., economic indicators have given notably weak readouts on consumer prices and individual consumption. Long-term interest rates, which are supposed to follow benchmark rate hikes, have stayed sluggish, and touched a roughly seven-month low Wednesday, the day the Fed made its announcement. Some suggest this is because the markets were pricing in a possible U.S. economic slowdown.
Kuroda has suggested a belief that U.S. interest rates may continue to rise, but if U.S. economic prospects grow hazy, the outlook for the BOJ's policies will darken.