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The Bank of Japan surprised the financial markets this week by unexpectedly ¥400 billion ($3.6 billion) of government bonds. The central bank withdrew debt securities with maturities of 5 to 10 years from the market on Thursday to prevent the interest rate on 10-year government bonds from rising further. Earlier that day, this interest rate rose to 0.145%, the highest level in a year and a half.
The intervention is controversial because the Japanese government had issued new government bonds with a similar maturity on the same day. As a result, it is possible that the central bank has lent money directly to the government, a phenomenon that we only know from countries where hyperinflation has occurred. The central bank's direct financing of government deficits is seen by economists as a cardinal sin, which is why the Bank of Japan previously promised not to intervene on days when the government issues new bonds.
We can't find out whether the Bank of Japan actually bought bonds directly from the Japanese government, but we can conclude that the central bank is making increasingly crazy leaps to stabilize interest rates. In recent years, the Bank of Japan has tried to keep the interest rate on Japanese government bonds with a maturity of ten years within a range of +0.1% and -0.1% by intervening in the bond market. This range was recently extended to -0.2% to +0.2%, but it didn't take long for the central bank to defend this wider range as well.
The Bank of Japan is trying to buy fewer government bonds by no longer structurally buying a fixed amount of debt securities, but by intervening only at times when interest rates rise. In the period from April 2017 to March 2018, the central bank withdrew ¥50 trillion worth of debt from the market, less than its own target of ¥80 trillion annually. However, these unexpected interventions make the central bank's policy less predictable.
Bank of Japan eases bandwidth, but continues to intervene (Source: Bloomberg)
"Today's intervention calls into question the way the central bank communicates with the market. The Bank of Japan is taking too much risk, because buying bonds on the day of a bond auction is generally seen as problematic.", economist Toru Suehiro of Mizuho Secuirities Co. said in a statement to Bloomberg.
The Bank of Japan is trying to boost inflation and keep interest rates low by withdrawing more and more government bonds and stocks from the market. The resulting artificial scarcity ensures that interest rates remain low and that consumers, businesses and the government can borrow cheaply. Compared to other major central banks, the Bank of Japan goes much further, as its balance sheet total is already almost as large as its gross domestic product. By comparison, the balance sheets of the Federal Reserve and the European Central Bank are 20 and 42 percent respectively of the size of the underlying economy.
Here's another way to visualize the scale of the Bank of Japan's stimulus policy relative to its economy (and perhaps why these concerns over its sustainability exist)
— David Ingles (@DavidInglesTV) July 31, 2018
Balance sheet as % of GDP:
Fed 20%
ECB 41%
BOJ 98%
Let that sink in. pic.twitter.com/37gC6g93ym
This contribution was made from Geotrendlines
