Published: Thu, September 22, 2016
Economy | By Melissa Porter

Bank of Japan policy tinkering explained

Pushing yields on longer-term securities higher will be a boon to life insurers and other big institutional investors that have seen investment returns plunge after the BOJ imposed its negative interest rate policy in February. Both hawkish and dovish comments from Fed officials recently have stoked volatility in financial markets, although consensus is now centred on a U.S. rate rise by year-end. The US Fed had last gone for an interest rate hike in December 2015 when it raised raised its benchmark overnight interest rate to a range of 0.25 per cent to 0.50 per cent, the first hike in almost a decade. And markets are pricing in just a 22% chance that the Federal Reserve will raise its fed funds rate at Wednesday's meeting, Bloomberg data shows.

The central bank also kept its key interest rate on hold at -0.1%.

As a reminder, the stock market's impressive post-Brexit rally out of the late June low was stalled in July after the Fed's surprisingly confident policy statement that month proclaiming "near-term risks to the economic outlook have diminished".

Although it is seen as highly unlikely ( 20%) that they will hike interest rates, their future expectations for rates revealed in the statement, the dot plot and the Fed's economic projections will probably have an impact.

By suggesting that a rate hike is still "on the table" in the near-term, and by laying out an interest rate glide path for next year calling for multiple rate hikes, then the Fed could help insulate the US Dollar, plain and simple.

The BOJ introduced a new target for 10-year government bond yields of around zero percent and will buy government bonds to prevent yields from rising too far above that target.

The Fed also holds a policy meeting in early November, but investors have all but ruled out a rate move just days before the USA election.

Japan's currency has outperformed its developed-market peers this year, surging 18 percent against the greenback, amid doubts that Kuroda had adequate tools left to revive the economy as his goal of raising inflation to 2 percent proved elusive. The central bank called it a "new framework" to target persistent deflation in that country.

Perversely, such a strategy could weaken bond prices by causing inflation expectations to surge. The centerpiece of Japan's policy had been asset purchases, which will continue.

The perversity of the situation is that if the Fed hold off completely and give no indication of a December hike, it could cause worries in financial markets and cause equities to sell off, with traders questioning whether the Fed is genuinely concerned with the outlook of the U.S. and global economy.

Microsoft's shares rose 1.21 percent to $57.50 in premarket trading after the software maker raised its quarterly dividend and said it would buy back up to $40 billion. They therefore need to guide the market to a greater probability of a December hike from the current 55% that's being priced in.

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