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Dropping global bond yields and recession fears put BOJ in a bind

Tokyo

DOWNWARD-SPIRALLING bond yields and other signs of global recession have strung a tightrope for the Bank of Japan (BOJ): it must keep pumping money to spur growth, but also prevent borrowing costs from sliding too far below the target.

If yields keep falling, they could force the BOJ to take a deeper look at the feasibility of yield curve control (YCC), some analysts say. The policy, aimed at preventing long-term interest rates from sliding too much, is a centrepiece of the bank's efforts to stabilise the Japanese economy.

Takahide Kiuchi, a former BOJ board member and an executive economist at Nomura Research Institute, said: "The BOJ is powerless in stopping yield falls. It's a key flaw of YCC, which becomes dysfunctional when markets are too volatile. Leaving yield declines unattended would hurt the policy's credibility."

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The BOJ has flooded the economy with money since 2013, and has pledged to raise the pace of money printing until inflation is stable above 2 per cent. But it concedes that pushing down borrowing costs too far could lessen the impact of monetary easing, as it hurts commercial banks and discourages them from lending.

Under YCC, the BOJ guides short-term rates at -0.1 per cent and allows the 10-year Japanese government bond (JGB) yield to move roughly 40 basis points around a 0 per cent target.

Market players reckon that -0.2 per cent is the central bank's line in the sand, analysts say, but defending that number has proved tricky.

A modest cut in the BOJ's bond buying on Friday did little to raise the 10-year yield, which hit a three-year low of -0.255 per cent on Friday.

As Japanese yields fall, driven by global factors beyond the central bank's control, it won't seek to defend a specific level. Instead, the bank will allow market forces to drive bond moves as far as possible, said two sources who requested anonymity.

Theoretically, the BOJ could keep reducing bond buying to stem yield falls; it could also set a minimum yield for its bond-buying operations and refuse offers by financial institutions to sell at a lower rate.

But Shigeto Nagai, head of Japan economics at Oxford Economics, said these measures aren't as powerful as the central bank's tool to cap bond yields, that is, to offer to buy an unlimited amount of bonds at a set price.

Reducing bond buying would also cut against the BOJ's pledge to pump money into the economy to prop up growth and inflation.

The Federal Reserve and the European Central Bank are considering rate cuts. A BOJ that appears the least dovish among the major central banks could cause the yen to spike, hurting the country's exports.

Japan's economy grew an annualised 1.8 per cent in the April-to-June period; analysts say growth will sputter this year unless global demand rebounds quickly enough to offset an expected dip in consumption following a sales tax increase in October.

Kazuo Momma, a former BOJ official and an executive economist at Mizuho Research Institute, said: "The only way to stop yield falls is to dramatically trim bond buying. But that's hard to do because the BOJ also promises to increase money printing. Markets are testing the BOJ's resolve to defend the floor for yields, but I don't think the BOJ has a clear idea on how to deal with this problem." REUTERS