Next BoJ governor hints at a return to policy orthodoxy

We think the BoJ’s next governor, expected to be respected scholar Kazuo Ueda, will shift cautiously to a more orthodox policy framework centred on the control of the short-term policy rate. Although Ueda will likely maintain the zero-interest rate policy, we think he will also look to reduce the side-effects of some measures including the Yield Curve Control (YCC) policy.

What you will learn:

• To buy time for the review amid persistent market pressures, the BoJ will likely widen the tolerance band for the 10-year JGB yield from 50 bps to 75bps or 100 bps in Q2. Though an outside chance, we don’t exclude a decision as early as the March meeting to ensure a smooth transition period. But even after widening the band, we believe that it will remain as a safeguard against yields potentially overshooting during the process exiting QE.
• We think the review is likely to conclude that progress towards achieving the 2% inflation target has been made and that the current accommodative monetary policy stance should be continued with some adjustments to reduce side-effects. This will give the BoJ flexibility to adjust the policy framework by reversing some easing measures before achieving the 2% target in a stable manner.
• Possible adjustments the BoJ could consider include ending the negative short-term policy rate that has hampered financial intermediation in money market. The BoJ will likely maintain the short-term policy rate at 0% to support the economy and to keep long-term yields low.
• We project very cautious steps to exit from aggressive QE policy. Although Ueda would like to see more market-led formation of long-term yields, the reduction in the pace of JGB purchases will be gradual. 
• Our revised BoJ policy outlook will have a relatively limited impact on growth and inflation with little change in short-term rates and bank lending rates.