As deflation deadline nears, BOJ faces prospect of failure

By Reuters

Oct 30, 2014 09:13 AM EDT

With just five months left before Governor Haruhiko Kuroda's self-imposed deadline for banishing deflation, the Bank of Japan is preparing for failure, and the first casualty could be its facade of board unity.

There is almost no way the central bank can hit the two-year, 2 percent inflation target Kuroda set when he unleashed unprecedented monetary stimulus in April 2013. Economists think it is unlikely to even get close in the foreseeable future.

That could undermine Kuroda's so far unchallenged authority to implement radical policies and cast doubt on his money-printing drive to revive Japan's economy, interviews with more than a dozen current and former BOJ officials and insiders show.

"The board members gave Kuroda's experiment a one-year moratorium," said a former central bank board member who still has close contacts with incumbent policymakers. "They decided to wait-and-see for a year. But now it's time of reckoning."

A divided board could undermine the public confidence essential to Kuroda's success in embedding expectations of inflation, and leave markets fretting about how authorities will deal with the central bank's massively expanded balance sheet.


Kuroda has been relentlessly optimistic even as the economy, hit by a sales tax hike in April, flirts with recession and falling oil prices threaten to pull inflation below 1 percent.

But most of his policymaking board has always been quietly skeptical of his signature "quantitative and qualitative easing" (QQE), a policy that floods liquidity into the banking system to end 15 years of falling prices, and now the fissures are widening.

Kuroda says inflation will accelerate again, but also that the BOJ will expand monetary stimulus should the 2 percent target be at risk - something many on the board question.

People close to Kuroda say his conviction the BOJ can meet its inflation target is genuine and not just aimed at boosting sentiment, and that the governor still sees the next policy move as an exit instead of a further expansion of stimulus.

The chance of open revolt against the governor is slim, in part because there is no consensus among the dissenters and Kuroda can count on the support of his two deputies, who were appointed around the same time as him.

But the board's two market economists and two businessmen are either skeptical of QQE or hesitant to maintain it for too long. The two academics are hard to predict.

The doubts about the current stimulus signal that the prospect of further easing is also anathema to some, who say the BOJ is already struggling to force-feed free cash to markets. It has had to contend with negative interest rates at some debt auctions.

"Many are confused as to what to do next," said one official familiar with the board's deliberations.

The BOJ policymakers are set to maintain their upbeat price forecasts at a rate review on Friday, as ditching them could stir unwelcome market speculation of immediate monetary easing. [ID:nL3N0RX0RX]

But skeptics of the current framework may propose ditching the two-year timeframe for meeting the target, by using more ambiguous language to explain when the price goal may be met.

In a hint in that direction, Deputy Governor Kikuo Iwata told parliament on Tuesday that there was uncertainty on exactly when inflation would hit 2 percent. "It's not set in stone like a train timetable," Iwata said.

While there is no consensus on the matter yet, discussions may kick off on Friday and intensify in coming months, particularly if economic growth remains anemic.


No governor has been outvoted by the board since the BOJ gained independence from the government in 1998. But the divisions could mean a split vote if Kuroda does propose further easing, interviews with more than a dozen current and former BOJ officials and other insiders show.

"Kuroda won't propose easing unless he's sure he won't be outvoted. Still, unlike last April, it will probably be a split vote," said prominent BOJ watcher Izuru Kato, chief economist at Totan Research. [ID:nL3N0SH030]

"That won't look very good to markets."

On coming to office, Kuroda galvanized the nine-member board, six of whom had previously voted with his more cautious predecessor, into going along with his shock-and-awe plan.

During the transition, the board members had to swallow a drastic overhaul of monetary policy in less than a month. Faced with enormous public support for Kuroda's radicalism, some conceded to QQE despite their reservations.

Kuroda launched unprecedented stimulus that would see base money doubled within two years, with the BOJ buying up to 70 percent of new government bonds each month as well as buying riskier assets, to lift inflation to 2 percent by April 2015.

Now, there are growing doubts, particularly over the two-year timeframe. Kuroda's top-down approach and pragmatism have also ruffled the feathers of some board members, accustomed to former governor Masaaki Shirakawa's consensus-building style.

The fragmentation could prompt the board members to send conflicting messages on the BOJ's policy outlook through public appearances, diluting the psychological effect of QQE.

"Everyone needs to feel a sense of ownership for unorthodox policies to work. That's not there in the current board," said a former BOJ policymaker who has close contact with incumbent board members.


The two market economists on the board, Takehiro Sato and Takahide Kiuchi, have made clear from the outset their doubts about the 2 percent target - a rate modern Japan has seldom hit, even during the bubble years. They argue the target should be set lower or in a loose range centering around 1 percent.

The two academics, Sayuri Shirai and Ryuzo Miyao, endorsed QQE without much resistance. But since then Shirai, the only woman on the board, has joined the chorus of scepticism and spearheaded the drive to water down the commitment.

Sato, Kiuchi and Shirai dissented on the BOJ's upbeat price outlook in April. Shirai says Japan won't see inflation hit 2 percent until the fiscal year ending in March 2017.

In a concession, Kuroda has already tweaked his message. Some months ago, he began fudging the hard two-year timeframe for the inflation target to the fiscal year beginning April 2015, effectively giving the BOJ up to an extra 12 months.

What worries BOJ bureaucrats the most, however, is the silent discontent of Koji Ishida and Yoshihisa Morimoto, who they see as holding the key in future policy discussions.

The 67-year-old Ishida is an elite commercial banker who favors discipline and consistency, and his position as the elder statesman of the board carries a lot of weight.

Having seen decades of BOJ money-printing crush yields but fail to boost lending, Ishida feels QQE should not last too long and an exit strategy is needed. Ishida has spoken against Kuroda's policies in BOJ meetings and when he does, people listen, say officials with knowledge of the deliberations.

Morimoto, a former utility executive, shares Ishida's concerns on the risk of maintaining QQE for too long, such as making an exit more difficult and distorting financial markets.

Morimoto was the strongest opponent of QQE and was the last board member to consent, baulking at the sheer size of asset purchases and the risk of loading up the BOJ's balance sheet with long-term debt.

It was only after intense rounds of persuasion by Kuroda and one of his deputies, Hiroshi Nakaso, that Morimoto relented. He has voted with the majority since then, but remains resentful of the way QQE was ushered in, people close to him say.


Even Kuroda's two deputies have their differences. Iwata, a former academic and an architect of QQE, strongly believes that if the central bank expands its balance sheet aggressively enough, inflation will eventually accelerate.

Nakaso, a career central banker who engineered the end of the BOJ's previous quantitative easing in 2006, is less sure and warns of the need to be mindful of how the bank may exit QQE.

While Kuroda's optimism reflects his character and the need to brighten public sentiment with an upbeat message, critics say it is making the BOJ appear out of touch with the real state of the economy, which is barely growing.

Kuroda is keen to leave QQE in place even after inflation hits 2 percent, to ensure deflation is vanquished. But some board members are strongly opposed to that, arguing that it is a temporary, extraordinary and expensive measure.

"Kuroda left himself no wiggle room, so he'll charge ahead. That's his style," said a former financial bureaucrat close to Kuroda. "It's not for everyone."

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