Bank of Japan Deputy Governor Kikuo Iwata ruled out using its policy ammunition to deal with temporary market turbulence, signaling that it would take a long-term decline in price expectations for him to consider additional monetary easing.
Iwata, a vocal advocate of reflationary policies, also said that if the central bank were to boost asset purchases in the future he would favor government bonds over risky assets, given the huge size of the Japanese government bond market. The BOJ stunned financial markets on April 4 by setting in motion an intense burst of monetary stimulus, promising to double its bond holdings in two years and boost purchases of risky assets in an attempt to jolt the economy out of deflation.
Some market players have speculated that the central bank may boost purchases of riskier assets, such as trust funds investing in stocks and property, if recent market turbulence persists and threatens the prospects of an economic recovery.
But Iwata, who joined the BOJ with Governor Haruhiko Kuroda in March as one of his two deputies, said he would focus on long-term price expectations in judging whether further monetary stimulus was necessary.
"We still have policy options. Still, I wouldn't say that downside risks have increased unless price expectations showed long-term declines," Iwata told Reuters in an exclusive interview, his first since taking office. "I'm focusing on whether Japan can achieve 2 percent inflation in a very stable and long-term manner. The economy can temporarily undershoot. This happens all the time. It could also temporarily overshoot. We have to look at the long-term."
A 70-year-old former economics professor, Iwata has long blamed BOJ hesitation for prolonging the deflation that has dogged Japan for nearly two decades, and has argued that the bank can beat deflation alone if it pumps enough money into the economy. His ideas have served as a backbone of the BOJ's unprecedented easing moves, such as setting a two-year timeframe for achieving its 2 percent inflation goal and buying assets aggressively under a policy targeting base money, the total amount of cash and bank deposits, instead of interest rates.
Financial markets have rallied strongly since Prime Minister Shinzo Abe highlighted his brand of aggressive policymaking late last year, followed by the BOJ's announcement in April. But Japanese shares are now lower than when the BOJ unveiled its stimulus, casting doubt on the bank's reflationary tactics that rely heavily on lifting sentiment and confidence.
The yen is stronger against the dollar, worrying exporters, while the massive scale of the BOJ's buying jolted markets and nudged bond yields above levels before April 4. Iwata sounded unfazed by what he saw as a temporary move in markets that were still coming to terms with the bank's massive monetary easing, stressing that the recent market moves have yet to hurt the economy enough to warrant additional stimulus.
"It's important for central banks to communicate well its policy intention to markets. But they must not be unsettled by market moves," he said. "A short-term response will only have a temporary effect on markets. What's important is fundamentals. The market moves haven't affected Japan's economic fundamentals, which are in good shape and improving."
JGBS BETTER THAN RISKY ASSETS
Iwata believes that by making a strong commitment to meeting its price goal, the BOJ can change the public's perception that deflation will persist. If companies expect prices to rise in the future, they will boost capital expenditure and wages, which would then encourage households to spend more, he said.
"Regardless of whether it's intentional or unintentional, monetary policy affects expectations. You can't talk about monetary policy without talking about the effect on expectations," he said. "Rising inflation expectations show that sentiment is improving about the future, and we are already seeing this happen."
Preliminary estimates show Japan is likely to see inflation reach 2 percent around the April-June quarter of 2015, Iwata said, although he added that there was strong uncertainty on when exactly the price goal would be met as it would be influenced by various factors like global economic developments.
But some in the nine-member BOJ board disagree with his upbeat view on prices and are cautious about putting too much emphasis on the psychological effect of monetary policy.
Takahide Kiuchi, for one, has argued that setting a two-year timeframe for the BOJ's price goal is unrealistic and erodes the bank's credibility as many private-sector analysts think it will take much longer for Japan to see 2 percent inflation. There are also differences in views within the board on how to respond to the recent market volatility, and what kind of assets the BOJ should buy if it were to ease again.
Iwata said that he would prefer government bonds over riskier assets. But some in the BOJ are against boosting JGB buying, given the central bank has already disrupted markets by gobbling up 70 percent of new bonds issued each month. Iwata said he saw little need now to consider offering longer-term funds through cheap, fixed-rate market operations, an idea the BOJ board debated, but turned down, at a rate review earlier this month as a means to calm bond markets.
"If volatility remains very high for a very long time, we might have to think about a response. But for now, I think markets are stabilizing," he said. Despite his sanguine comments on markets, Iwata acknowledged that his first couple of months at the BOJ weren't easy.
"It's been just over two months but it feels longer than that," he said. "It seems long because this is my first time spending so much time every day watching market moves."
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