At its meeting on 21 September, the BoJ unveiled a "new framework for strengthening monetary easing". It will now target 10-year Japanese government bond (JGB) yields, aiming to keep them close to 0%, instead of targeting an annual expansion of the monetary base. It expects to continue purchasing assets at a similar rate as before - JPY80trn per year. However, Fitch believes that the shift could ultimately lead to a slower rate of asset purchases, if the bond market starts to put downward pressure on 10-year yields.
The BoJ changed the policy framework in response to its review of the effects of quantitative and qualitative easing and negative interest rates. The review acknowledges the potentially damaging effects that negative rates and, in particular, a flattening of the yield curve could have on economic confidence and the functioning of the financial system. Yields on 10-year JGBs have been negative for much of this year, and have often dipped below short-term interest rates. This has made it difficult for financial institutions to generate profit by lending at longer maturities than they borrow, and could be creating a reluctance to lend.
The central bank is aiming to tackle this problem by taking control of the yield curve. The policy to keep long-term rates near current levels paves the way for the BoJ to lower the policy rate further without necessarily undermining the financial sector. We now expect the policy rate to be taken down from -0.1% to -0.5% by end-2017.
The BoJ also committed yesterday to keep loosening monetary policy until consumer price inflation exceeds and stays above the 2% target. It hopes that a promise to "overshoot" the target will lift inflation expectations. However, expectations have proved stubborn even through the "shock and awe" of Abenomics. The central bank faces clear doubts over whether it has the tools to boost the real economy and deliver on the inflation target. Moreover, its credibility could be further undermined by having to rely on ever more complicated policies to ensure it is helping, not hurting, the economy.