Bank of Japan seen highlighting negative rates as main policy tool

By Leika Kihara

TOKYO (Reuters) - The Bank of Japan is expected on Wednesday to make negative interest rates the centerpiece of a new policy framework - widely seen as a desperate attempt to show it still has the means to fight chronic stagnation.

But shifting its policy focus away from base money, or the pace at which it prints money, may heighten rather than dispel market concerns that central banks have reached the limits of reflating their economies with monetary tools, analysts say.

With three years of massive money printing failing to push up inflation, the BOJ is expected to move away from the shock therapy of massive stimulus toward a more protracted battle against deflation, say sources familiar with its thinking.

"You can't do a regime change so many times," one of the sources said on condition of anonymity. "A more flexible policy framework may be needed."

Many central bank policymakers believe the best way to make this change is to focus on cutting rates rather than topping up an already huge bond-buying program that is draining away market liquidity.

The BOJ may even consider deepening negative rates on Wednesday to show its determination to maintain an ultra-easy policy bias, though whether to deploy one of its dwindling options so soon would be a close call, sources say.

Analysts also warn the BOJ would only be able to deepen negative rates a few more times to around minus 0.5 percent before households begin to hoard cash for fear of being penalized for depositing money at banks.

"The BOJ insists that it still has many tools available. But the costs of using these tools are rising and the benefits are diminishing, especially for its huge asset purchases," said Izuru Kato, chief economist at Totan Research.

"Deepening negative rates has enormous costs too but practically, that's probably the only usable tool left."

This less aggressive approach would come as a world of tame growth and low inflation force the U.S. Federal Reserve to go slow on raising interest rates and the European Central Bank to concede the limits of what monetary policy alone can achieve.

More than 60 percent of analysts polled by Reuters expect the BOJ to ease further on Wednesday, though they are divided on what its next move is likely to be.

DIVIDED BOARD

The BOJ's "quantitative and qualitative easing" (QQE) has been a signature policy of Governor Haruhiko Kuroda since 2013, which intended to shock the economy out of stagnation and change households' deflationary mindset.

While the central bank is unlikely to ditch QQE completely, altering its emphasis would herald an end to the "shock and awe" approach that made Kuroda's policies unique compared with the gradualist approach preferred by his predecessors.

Under QQE, the BOJ has been increasing base money - or the amount of money it prints - at an annual pace of 80 trillion yen ($787 billion).

Sources have told Reuters the BOJ will shift its prime policy target to the 0.1 percent negative rate it charges on a portion of excess reserves financial institutions park with the central bank that was introduced in February.

Wary of a flattening yield curve that risks impairing financial intermediation, it will also seek ways to steepen the curve such as making its bond buying more flexible.

The challenge for the BOJ will be how to back away from QQE without scaring investors into a stampede out of bonds.

Kuroda must also muster consensus from a fragmented board, where even those who favor more easing are divided over the most effective method. Some want to shift to a rate target, but others want to keep focusing on expanding asset purchases.

($1 = 101.6900 yen)

(Reporting by Leika Kihara; Editing by Eric Meijer)

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