Kuroda flags Japan real-yield drop to show stimulus is working

[TOKYO] As consumer prices stagnate, the Bank of Japan is pointing to falling inflation-adjusted yields as evidence its stimulus program is lifting expectations for living-cost increases.

Japan's 10-year government bonds yield a negative 0.54 per cent when adjusted for the expectations included in inflation-linked debt prices, while the similar measure for the US is a positive 0.45 per cent. Since the start of the year, projections for inflation over the next decade have climbed 20 basis points, while estimated real yields for the period have fallen 12 basis points, according to data compiled by Bloomberg.

BOJ Governor Haruhiko Kuroda last month emphasized the effect of monetary policy on inflation expectations and real yields as he reiterated confidence in reaching a two per cent inflation goal. That suggests he will stick to the current level of stimulus, even as the central bank's preferred gauge of consumer prices has flat-lined this year.

"Remarks about the decline in real yields have been on the rise because the BOJ wants to emphasize the effectiveness of quantitative easing," said Kazuhiko Ogata, a Tokyo-based economist at Credit Agricole SA. "They seem to be struggling to show their policies are working." The BOJ's stimulus, which has scope to snap up every new bond the government issues, is pushing down nominal yields to the lowest globally after Switzerland. The 10-year bond yield slumped as low as a record 0.195 per cent in January, and was at 0.405 percent as of 10:45 am Tuesday in Tokyo. The equivalent US Treasury note yielded 2.16 per cent.

Even as break-even rates have climbed this year, core consumer prices, which strip out food costs and the effects of last year's consumption tax hike, have hovered between zero and gains of just 0.2 per cent since January following oil's biggest plunge last year since the financial crisis.

Kuroda reiterated that underlying prices continue to improve steadily and no additional stimulus is needed at this time, in an interview with the Yomiuri newspaper on July 31. He repeated his view that price gains would accelerate significantly later this year.

"By focusing on inflation expectations instead of actual inflation, the outlook appears much better," said Hideo Kumano, an economist at Dai-ichi Life Research Institute Inc in Tokyo. "By focusing on real yields, policy makers can better foster a sense that they're doing the right thing by waiting instead of rushing to expand stimulus." More than a third of 35 economists surveyed by Bloomberg last month now predict the central bank won't add to bond purchases.

Kuroda identified a drop in real yield as one of the main transmission channels between the central bank's quantitative easing and the actual economy when he first introduced the program in April 2013.

"A rise in the expected inflation rate will not only influence actual prices but also stimulate private demand through a decline in real interest rates," he said at the time.

Private demand continues to be weak, with retail sales slipping 0.8 per cent in June from the previous month. Wage growth has also been lackluster, failing to keep up with the marginal rise in consumer prices.

"The BOJ feels forced to defend its stimulus program because a lot of companies and households doubt if it's really having an effect," said Credit Agricole's Ogata. "It's very hard to see the impact on the actual economy."

BLOOMBERG