The logic of Ueda’s Bank of Japan

Following its first policymaking meeting, it appears that the new Bank of Japan (BoJ) under Kazuo Ueda is just like the Kuroda BoJ. Despite the superficial similarities, however, the underlying logic of policy management decisions may be quite different.

First, Ueda restored the link between monetary policy management and the inflationary trend, including wages. This means that while monetary easing must be continued for now, a shift to tighter monetary policy can happen as soon as it is determined that the inflation trend is upward. This is a major difference from the BoJ under Haruhiko Kuroda, which had ruled out any discussion of monetary tightening as premature. The Ueda BoJ clearly indicated that the inflationary trend should be judged comprehensively based on wages, corporate profits, employment, expected inflation and other factors. Although the inclusion of wages in the inflation assessment may lead some to believe that monetary easing will be prolonged, the achievement of the inflation target should lead to a higher quality of life for the Japanese people. So this actually may be a more appropriate policy direction. In any case, monetary policy will change according to the judgment of the underlying inflation trend. The logic of the policy management differs from that of Kuroda’s BoJ, which had ultra-loose monetary policy firmly in place almost regardless actual situations.

Markets believe that the BoJ will need to revise its Yield Curve Control (YCC) program because of the side effects already observed last year. Therefore, the market consensus view was that YCC revision would be the first action item for the new BoJ, and that it could be announced at the first meeting. Apparently, however, Ueda does not seem to be thinking that way. Under the BoJ's logic, there is no need to revise the YCC at this point. This is because of its view that inflation is likely to decline in the future and foreign interest rates are currently declining. As a result, from a cost-benefit perspective, the need for a YCC revision is low, according to Ueda. Conversely, this same cost-benefit thinking asserts that the YCC should be revised whenever there is a change in the environment, such as an increased likelihood of higher inflation or higher foreign interest rates.

In the BoJ’s new forward guidance, which was revised at this meeting, while reinforcing the link between inflation and monetary easing, it excludes interest rates and YCC from its scope. In other words, it can be understood as a commitment to monetary easing until the inflation target is achieved, but the instrument need not be a YCC. The new forward guidance is considered to have the effect of increasing the flexibility of interest-rate fluctuations other than short-term interest rates. This can also be regarded as one of the measures to enhance responsiveness to changes in the inflationary environment.

In addition, the BoJ’s current policy calls for it to conduct a 25-year review over a period of one to one-and-a-half years. Presumably, the yen bond market interpreted the news of this long-term review as a prolonged period of monetary easing, and the yield curve flattened from the super long-term zone. However, Governor Ueda made it clear at the press conference that the review and the policy of the moment are two different things. In other words, even during the review, monetary policy can be changed in response to changes in the environment.

Given his recent words and actions, some may perceive Governor Ueda as an ultra-dovish policymaker. However, we believe that he is simply judging that the current inflation assessment is fundamentally inadequate relative to the achievement of the 2% target. If his judgment of inflation changes, his policy direction should change as well.