On the heels of the Bank of Japan's new framework for strengthening its monetary easing, traders are wondering what effect it will have on the gold market.
The BoJ proved again that it is at the forefront of central banking and changed its monetary policy framework. After a comprehensive review of the measures used so far, Kuroda and his colleagues introduced “QQE with Yield Curve Control”, which consists of two major components: “yield curve control” and the inflation over-shooting commitment.
The New Tools
“Yield curve control” means an interest-rate target for 10-year government bonds. It is not a completely new measure, as the Fed targeted rates for long-term securities during WWII and in the postwar years, when it pegged the interest rate on Treasury bills at 0.375 percent and enforced a ceiling of 2.5 percent on the rate on long-term Treasury debt. The BoJ committed itself to purchase 10-year government bonds so that yields will remain around zero percent. It could be a coincidence, but the measure was introduced after Ben Bernanke’s recent visit to Japan. The former Fed Chair recently argued that “targeting longer-term interest rates could be a useful additional tool for the Fed when short-term rates are zero”.
The adoption of inflation over-shooting is no less interesting, as it means that the BoJ essentially departed from the 2-percent inflation target:
The Bank commits itself to expanding the monetary base until the year-on-year rate of increase in the observed consumer price index (CPI) exceeds the price stability target of 2 percent and stays above the target in a stable manner.
In other words, Kuroda listened carefully to the voice of Paul Krugman, who has argued for years that central banks should make a deliberate “commitment to be irresponsible”.
The BoJ kept rates steady, but said that it could cut the rate further as a measure to step up its easing action. It also maintained its target of buying ¥80 trillion of Japanese government bonds a year, however, the expansion of the monetary base depends now on the efforts to keep the long-term interest rates target.
The key takeaway is that the BoJ's September statement was in a sense revolutionary, as the Japanese central bank changed its monetary policy framework, by introducing longer-term interest-rate targeting and by departing from the traditional 2-percent inflation target. Kuroda effectively signaled that he is ready to do “whatever it takes” to generate inflation. Will the markets believe him? We will see, but the yen initially declined and the U.S. dollar rose. The price of gold initially fell, probably on the stronger greenback, but it quickly rebounded. The BoJ’s new easing lowers the probability of a hawkish move by the Fed later today, which is positive for the gold market (but we cannot say the same about the stronger U.S. dollar). The adoption of negative interest rates by the BoJ was interpreted as an act of desperation and caused the rally in gold prices. Could we see now a similar scenario? Well, it’s probably too early to say – let’s wait for today’s statement from the Fed. Stay tuned!