Will BoJ’s New Framework Become A Turning Point For Gold?

The Bank of Japan announced in September a cocktail of new monetary policy measures, called “QQE with Yield Curve Control”. Let’s analyze these innovations in detail and discuss their potential implications for the gold market. As we have already noted in the Gold News Monitor, the package consists of two components:

• The promise to keep expanding the monetary base until inflation “exceeds the price stability target of 2 percent and stays above the target in a stable manner”;
• The pledge to cap 10-year government bond yields at zero percent.

Let’s start from the commitment to overshoot the inflation target. Generally speaking, this change is very similar to the hike of the inflation target, especially since the BoJ has not defined the “stable manner”. It may assure investors that the BoJ will continue its loose monetary policy even if inflation reaches the 2-percent target. However, nobody knows what “stable manner” means and how long the inflation rate should remain above the target to please the BoJ, so the promise reduces the transparency of the BoJ’s actions. Therefore, as we wrote in the last edition of the Market Overview, the move could increase the risk of higher inflation, which should be positive for the gold market, since the yellow metal usually shines during periods of high and rising inflation, low real interest rates and diminished confidence in the central banks. However, there are two problems. First, weaker yen would translate into a stronger greenback, which should be negative for gold. Second, investors do not believe that the BoJ will be able to overshoot its 2-percent inflation target. It should not surprise us: the monetary policy has not worked in Japan for decades. Why would that suddenly change? Why should the BoJ suddenly produce an inflation rate higher than its target, given the inability to merely meet it for years?

Now, let’s move to the yield curve control. The BoJ adopted yield targeting with the aim of anchoring the 10-year government bond yields at zero percent. On the surface, it seems to be a very nice policy which implies that the BoJ is ready to purchase all bonds investors want to sell. It is always good for investors to have an option to sell their securities at a known price. However, there are three problems with the BoJ’s yield control (except an obvious risk of giving up control over the size of the central bank’s balance sheet and purchasing most or all of the eligible securities when defending a peg).