Analysis: Kuroda to ride out market storm without more stimulus

By Leika Kihara

TOKYO (Reuters) - Bank of Japan Governor Haruhiko Kuroda has no intention of blinking first in the face off with Japan's markets over policy even as central bank officials grow increasingly worried about price volatility.

A selloff in Japanese stocks, a sharp rise in bond yields and a pullback in the dollar against the yen have raised doubts about the effectiveness of the BOJ's big-bang stimulus program announced on April 4 and whether it will need to take further action to revive the moribund economy.

But Kuroda wants the BOJ to ride out the market storm by sticking to the central bank message that an injection of $1.4 trillion into the economy over two years will do the job of reinflating the economy. The policy aims to turn around years of deflation to achieve 2 percent inflation in two years.

The BOJ hopes the market volatility will be calmed as a pick up in the economy persuades investors that monetary policy is working, sources familiar with central bank thinking say.

"The BOJ has said very clearly it will not take incremental action," a source said. "That doesn't mean the BOJ will not act when needed. But it does mean it won't act easily."

Kuroda said on Wednesday an important merit of monetary policy is flexibility. But the sources, who spoke on condition of anonymity because of the sensitivity of the subject, said the BOJ has no new stimulus plan in the works, nor is it pondering alternative measures beyond its current set of policies.

Any change in policy now would undermine Kuroda's message to financial markets that the BOJ has moved away from the incremental approach to policymaking that was heavily criticized under his predecessor, they say.

To critics, the BOJ's rigid message suggests it lacks a strategy on what to do next, especially as there are doubts even within the BOJ that the central bank can meet its 2 percent inflation target in two years - doubts shared by many economists.

"By stressing it will not take incremental action, the BOJ sacrificed the freedom to act flexibly in response to sudden market shocks or other risks to the economy," said Masaaki Kanno, chief Japan economist at JPMorgan Securities in Tokyo.

"It's also unclear what the BOJ plans to do once it becomes evident Japan won't see 2 percent inflation in two years. Would it step on the gas pedal again? The whole uncertainty is contributing to the market volatility," he said.


The BOJ stimulus program relies heavily on lifting sentiment and confidence, so the reaction in markets is important.

Financial markets have rallied strongly since Prime Minister Shinzo Abe first highlighted his brand of aggressive policymaking late last year.

But Japan's benchmark Nikkei average <.N225> is now lower than it was when the BOJ announced its stimulus. The yen is now stronger against the dollar, worrying exporters.

The sources said BOJ officials were particularly worried about persistent swings in the Japanese government bond market because it can curtail lending.

"When volatility is so high, companies may hesitate raising funds from the market or making fresh investment," said a source familiar with the BOJ's thinking. "It's unfortunate markets haven't calmed down yet."

The yield on the benchmark 10-year bond fell to a record low of 0.315 percent the day after the BOJ announced its new monetary policy, which included a promise to keep yields low by buying 70 percent of newly issued bonds.

But the scale of the buying jolted markets, crowding out other buyers and prompting a rush to sell. By May 23, the 10-year yield had risen to a one-year high of 1.00 percent and on Wednesday was around 0.8 percent.

On the other hand, data is showing signs of a pick up in the economy, welcome news for Abe and Kuroda. In the latest sign, a report on Wednesday showed exports rose in May at their fastest pace in more than two years.


The BOJ is also hesitant to act anytime soon in case doing so exacerbates the market volatility. Its big bond buying is already blamed for destabilizing the market, so increasing purchases could risk yet greater volatility.

Some traders have also speculated that the BOJ may raise the target for purchases of real-estate investment trusts, another part of its monetary policy aimed at supporting prices. The BOJ is close to its year-end goal of buying 140 trillion yen ($1.5 billion) in these investments.

Kuroda has already said there is not much room to boost buying sharply given the relatively small size of Japan's REIT market. Instead, the BOJ might opt to increase buying of exchange-traded funds although it is hesitant to do so now as it would expose its balance sheet to riskier assets.

The BOJ divisions over when Japan can achieve 2 percent inflation are also preventing agreement on increasing the central bank's tools for money market operations.

Last week, the nine-person board voted against extending the maximum duration of cheap, fixed-rate cash offered by the BOJ to two years from one year.

That would have made it easier for banks wrong-footed by the spike in bond yields to hedge their portfolios, reducing their need to sell bonds and potentially calming price swings.

Those opposed successfully argued the BOJ should not offer 0.1 percent money over two years if it expects inflation to be 2 percent at that stage. That would undermine the credibility of a central part of the BOJ's policy.

To calm the bond market, the BOJ needs to send a clearer, more consistent message on how it plans to guide policy beyond its two-year timeframe, said Izuru Kato, chief economist at Totan Research in Tokyo.

"The BOJ doesn't have a choice," Kato said. "It will quickly face a dead-end if it reverts to the incremental approach as it doesn't have enough policy options left to keep meeting market expectations."

(Editing by Neil Fullick)