‘No margin for error’: Bank of Japan’s next governor faces daunting challenge

With less than three months to go until Haruhiko Kuroda steps down as Bank of Japan governor, none of the top candidates to succeed the country’s longest-serving central bank governor appear to want the job.

Your reluctance is understandable. After a decade of “unprecedented” ultra-loose monetary policy, the next BoJ chief faces the daunting challenge of steering Asia’s most advanced economy towards normalizing interest rates.

If they fail, the consequences could be profound: a return to deflation and a sharp economic slowdown; turmoil in global stock, bond and currency markets; and a collapse in the Bank of Japan’s credibility.

“After three decades of low inflation, the BoJ finally sees a way to sustainably meet its 2 percent inflation target,” said Goushi Kataoka, a former Bank of Japan board member and now chief economist at PwC Japan.

“No candidate wants to be governor now because there is no margin for error. If he/she fails, it would undermine the central bank’s raison d’être,” he added.

The head of one of Japan’s largest banks said: “I hope that the new governor will be someone who doesn’t want to do the job. That’s because unless you know how difficult it’s going to be, this job is impossible. But when you know how challenging it will be, no one would want to do it.”

Despite a rather short list of likely candidates, analysts said there was unusual uncertainty about the selection process ahead of Prime Minister Fumio Kishida’s announcement next month of Kuroda’s successor, who is stepping down in April after a record 10-year tenure as governor.

BoJ observers believe the front runner is Masayoshi Amamiya, the bank’s deputy governor who is said to be its key currency strategist. Others in the running are Hirohide Yamaguchi, a former BoJ deputy governor and critic of Kuroda’s ultra-loose monetary policy, and Hiroshi Nakaso, another former deputy governor with strong ties to the international central banking community.

Deputy Governor Masayoshi Amamiya, a possible frontrunner for the post, is seen as the BoJ’s chief money strategist © Kiyoshi Ota/Bloomberg

All three leading candidates have privately expressed reluctance to take on the role, according to people familiar with the discussions.

Amamiya and Nakaso have closely supported Kuroda but are considered less moderate than the outgoing governor. Analysts said the election of Yamaguchi, also a BoJ insider, would signal markets a definitive break with the decade of aggressive monetary easing and stimulus pursued under the late former Prime Minister Shinzo Abe’s “Abenomics” policy.

But many inside and outside the BoJ said Amamiya was the natural choice given its role in shaping central bank monetary policy. “Of all existing BoJ officials, Mr. Amamiya has had the longest involvement in monitoring and making monetary policy decisions at critical moments,said Kataoka, the former board member of the BoJ.

The leadership change comes amid strong market pressure on the BoJ to back away from quantitative and qualitative easing as Japan’s core inflation rate – which excludes volatile food prices – has risen to a 41-year high of 4 percent.

Inflationary pressures are low compared to the US and Europe, but investors are increasingly betting that the BoJ will follow other central banks and tighten monetary policy.

The Bank of Japan defied those expectations last week by maintaining the main pillars of its easing program and saying it has no plans to abandon efforts to control 10-year government bond yields. Kuroda has repeatedly argued that price hikes have not resulted in sustained increases in wages and that easing is needed to prop up the economy amid the risk of a slowdown outside Japan.

With just one board meeting in March before Kuroda steps down, the future of his signature policy of yield curve control and negative interest rates will rest firmly in the hands of his successor.

“The new governor needs to be more persuasive than Mr. Kuroda to explain to foreign investors why Japan is struggling to sustainably meet its 2 percent inflation target,” said Kazuo Momma, former head of monetary policy at the BoJ, now the Executive Economist Mizuho Research Institute.

Momma cited market misperceptions of the overheating of the Japanese economy. “The biggest problem is that the BoJ is telling markets that it will continue monetary easing at least until the first half of 2023 or throughout 2023,” he said.

Regardless of their political stance, whoever succeeds Kuroda will be tasked with moving the BoJ away from the monetary stimulus introduced in 2013, said Ayako Fujita, chief Japan economist at JPMorgan Securities.

“The government will likely pick the next governor based on who can do policy normalization,” she said.

Kuroda opened what Kataoka called a “Pandora’s box” last month when the governor stunned investors by announcing that the BoJ would allow 10-year government bond yields to fluctuate 0.5 percentage points above or below their target of zero would replace the previous range of 0.25 points.

While Kuroda insisted the move would improve the functioning of bond markets and did not constitute monetary tightening, investors interpreted it as the start of policy normalization.

This intensified a battle between the central bank and the market. Traders tested Kuroda’s commitment to yield curve control, known as YCC, pushing 10-year Japanese government bond rates above the BoJ’s 0.5 percent target ceiling, while the central bank responded with blockbuster asset purchases.

JGBs have rallied in recent days after the BoJ introduced an expanded lending program to banks to stabilize the yield curve.

Fujita expects the BoJ to further raise the target cap to 1 percent by mid-year, effectively bringing 10-year JGBs close to where the market thinks they should be trading. She predicted that the central bank would then end its negative interest rate policy after a review in mid-2024 or later.

“There is no reason to rush the exit from negative interest rates as it depends solely on economic conditions,” Fujita said.

However, she said removing the yield target is crucial to restoring proper communication between the BoJ and markets, which are expected to continue challenging the central bank as long as the cap is in place

“After the YCC’s abolition, the BoJ should conduct a review of whether the YCC and its monetary policy were appropriate and what their costs were,” Fujita added.

Source : www.ft.com