Japan: Rise in inflation to 2% could trigger dual crises - Nomura

Mr. Kuroda’s current stance, under which the Bank refuses to comment on an exit from QE until inflation climbs to 2%, will maximize the risk of a JGB crash when inflation reaches the target level, according to analysts at Nomura.

Key Quotes

“If the BOJ were to begin winding down QE only after inflation hit the 2% mark, as demanded by Mr. Kuroda, there would be no private-sector buyers of the 10-year JGB unless yields rose to at least 2%, and possibly 3%.”

“But a 300bp increase in the 10-year government bond yield from current levels in a country where the national debt amounts to 250% of GDP would lead to a massive surge in interest expense, prompting fears about the potential fiscal crisis and a bankrupt BOJ. There is also a real probability that Japan’s sovereign rating would have plummeted by that point.”

“Further, this risk would increase significantly if the BOJ were the last of the four leading central banks to move to wind down QE. After all, who would want to buy ultra-low yielding JGBs from the BOJ at a time when government bonds in the UK, the US, and Europe were already offering adequate yields?”

“In short, Japan’s economy currently appears trouble-free only because the inflation rate is hovering around zero. If inflation were to rise to 2%, as Mr. Kuroda seeks, it could trigger balance sheet problems at the BOJ, with its huge portfolio of JGBs, and a government fiscal crisis resulting from the sharp increase in interest expense. This would entail severe and simultaneous problems at the sovereign and the central bank that are somewhat akin to the sovereign and commercial bank problems seen during the Eurozone crisis.”