Japan’s Money Printers Will Soon Be Under New Management

A decade ago the Bank of Japan led the way with an unprecedented experiment in monetary stimulus. To support Abenomics, named after then-Prime Minister Shinzo Abe’s aggressive bid to revive an anemic economy, the central bank massively increased purchases of government securities and eventually moved to cap yields on government debt. With the benchmark interest rate already negative, the combined effect was like having gigantic money-printing machines running constantly at full tilt.

Now, with inflation running well above the BOJ’s comfort zone, policymakers are having to ponder how best to make a monetary policy pivot that doesn’t spook markets.

This is the challenge facing Kazuo Ueda, who on Feb. 14 was nominated as central bank governoruniversity professor and onetime BOJ board member, Ueda, 71, has publicly said he will stay the course charted by Haruhiko Kuroda, who’s been in the post for a decade. Yet the expectation is that once installed in April, Ueda will move to end the policy of yield curve control, which sought to cap yields on longer-term government debt as a way to encourage banks to lend.

The combination of yield curve control and quantitative easing has turned the BOJ into the largest owner of stocks and government bonds in Japan, with a balance sheet of 735 trillion yen ($547 billion), equal to 130% of gross domestic product. Yet critics say that instead of reviving the economy’s animal spirits, these policies have forced Japanese investors to go overseas to earn a noticeable return on their money.

Japanese money managers alone have more than $3 trillion invested in overseas stocks and bonds, with more than half of that stashed in the US. The cohort—which includes the country’s giant insurers and pension funds—own more than $1 trillion in US Treasury securities and also hold bonds from Australia, France, the Netherlands and the UK.

If the BOJ were to raise rates too quickly, a lot of that money could come rushing back to Japan.

“Japan has employed ultraloose monetary policies longer than any other economy,” says Rob Subbaraman, head of global markets research at Nomura Holdings Inc. “So the exit from these policies could lead to major structural economic changes, such as the repatriation of a significant share of Japan’s massive fixed-income investments overseas.”

If Ueda defies expectations and sticks with easy money, that could lead to the reverse happening, with investors dumping Japanese assets. This would jeopardize the yen’s longtime reputation as a safe haven currency, causing it to drop in value against the US dollar and other currencies.

Under Kuroda, the BOJ stuck with a loose monetary policy even as inflation ticked higher and global peers raised interest rates. The thinking in Tokyo was that the rise in prices was transitory—a byproduct of surging costs for imported goods such as food and oil—and would eventually moderate.

But inflation is proving stickier than expected, with consumer prices rising to 4% annually in December, double the BOJ’s 2% target. Nominal wages in December rose at their fastest pace since 1997, and the current round of annual pay negotiations between companies and unions are being closely tracked for signs that Japanese workers will manage to extract larger-than-usual pay increases.

“My sense is that Japan is ready to move out of negative rates and [yield curve control],” says Alicia Garcia-Herrero, chief Asia-Pacific economist at Natixis SA. “The reason is simple: Core inflation is above the objective set by BOJ, and wages are increasing fast.”

Evidence of the potential for market turmoil in response to a BOJ pivot was clear in December when the central bank decided to allow 10-year yields to rise to about 0.5%, up from a previous limit of 0.25%, while keeping both short- and long-term benchmark interest rates unchanged.

Kuroda said the move was aimed at improving the functioning of the market, but it was widely seen as laying the groundwork for an eventual unwinding of the yield curve control program. That perception has forced the central bank to make ever-larger purchases to prevent yields from surging past the new limit: In January alone, it spent a record 23 trillion yen.

Under these conditions, Ueda may find he has little choice but to dial down the money printers soon after he takes up his post in the spring.