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

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

Their reluctance is understandable. After a decade of “unprecedented” ultra-loose monetary policy, the new BoJ chief must rise to the daunting challenge of leading Asia’s most advanced economy towards normalization of 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 path to sustainably reaching its inflation target of 2 percent,” said Goushi Kataoka, a former board member of the Bank of Japan and now chief economist of PwC Japan.

“For any candidate, you don’t want to be governor right now because there’s no room for error. If he/she failed, it would undermine the central bank’s raison d’etre,” he added.

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

Despite a fairly short list of likely candidates, analysts said there was unusual uncertainty surrounding the selection process ahead of Prime Minister Fumio Kishida’s announcement next month of Kuroda’s successor, who will step down in April after a record 10 years as governor.

BoJ watchers believe the frontrunner is Masayoshi Amamiya, the bank’s deputy governor, who is considered the chief monetary strategist. Other candidates include Hirohide Yamaguchi, a former BoJ deputy governor and a critic of Kuroda’s ultra-loose monetary policy, and Hiroshi Nakaso, another former deputy governor with close ties to the international central banking community.

Deputy Governor Masayoshi Amamiya, a possible frontrunner for the job, is considered the BoJ’s chief monetary strategist © Kiyoshi Ota/Bloomberg

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

Amamiya and Nakaso have closely supported Kuroda, but are considered less lenient than the outgoing governor. Analysts said the selection of Yamaguchi, another BoJ insider, would signal to markets a final break from the decade of aggressive monetary easing and stimulus pursued under the late former Prime Minister Shinzo’s “Abenomics” policies Abe.

But many inside and outside the BoJ said Amamiya would be the natural choice because of its role in shaping central bank monetary policy. “Of all existing BoJ officials, Mr. Amamiya has been the longest involved in observing and making monetary policy decisions at critical junctures.,said Kataoka, the former BoJ board member.

The change in leadership comes amid intense market pressure on the BoJ to deviate from quantitative and qualitative easing as Japan’s core inflation — excluding volatile food prices — has risen to a 41-year high of 4 percent.

Inflationary pressures are mild 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 bucked those expectations last week when it stuck to key pillars of its easing program and indicated it had no intention of halting efforts to control 10-year government bond yields. Kuroda has repeatedly argued that price increases have not led to sustainable wage growth and that easing is needed to support the economy amid the risk of a growth slowdown outside Japan.

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

“The new governor will have to be more persuasive than Mr. Kuroda to explain to foreign investors why it is difficult for Japan to sustainably meet its inflation target of 2 percent,” said Kazuo Momma, former BoJ monetary policy chief. now executive economist at Mizuho Research Institute.

Momma cited market misconceptions about overheating in the Japanese economy. “The biggest problem is for the BoJ to communicate to markets that it will continue monetary easing at least through the first half of the year or all of 2023,” he said.

Whatever their policy stance, whoever succeeds Kuroda will be tasked with distracting the BoJ from the monetary stimulus launched in 2013, said Ayako Fujita, chief economist Japan at JPMorgan Securities.

“The government will probably choose the next governor from the point of view of who can normalize policies,” 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 Treasury yields to fluctuate 0.5 percentage points above or below the target of zero, replacing the previous margin of 0.25 points.

While Kuroda insisted the move would improve bond market functioning and did not imply monetary tightening, investors interpreted it as a trigger for 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, which drove 10-year Japanese government bond yields above the BoJ’s 0.5 percent ceiling as the central bank responded with blockbuster bond purchases.

JGBs have rebounded in recent days after the BoJ introduced an extensive program of lending to banks to stabilize the yield curve.

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

“There is no reason to rush out of negative interest rates, as that depends entirely on economic conditions,” Fujita said.

But she said ending the yield target would be vital to restoring good communication between the BoJ and markets, which are expected to continue to challenge the central bank as long as the cap is in place.

“After removing the YCC, the BoJ would have to assess whether YCC and its monetary policies were appropriate and what their costs were,” Fujita added.

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