Incoming Bank of Japan (BOJ) Governor Kazuo Ueda has said the central bank must maintain ultra-low interest rates to support the fragile economy, warning of the dangers of responding to cost-driven inflation with monetary tightening.
While signalling the chance of tweaking the BOJ's bond yield curve control (YCC) in the future, Ueda said the bank needed to work out the right timing and means to do so, a sign the new chief will be in no rush to overhaul the controversial policy.
Speaking to lawmakers, Ueda said the recent acceleration in inflation is driven largely by rising raw import costs, rather than strong demand, adding the outlook for Japan's economy was highly uncertain.
Global bond yields fell and Japanese stocks rallied as Ueda's emphasis on continuity in policy tempered some market expectation that he might seek to make a hasty exit from the extreme stimulus of his dovish predecessor, Haruhiko Kuroda.
"It's standard practice to act preemptively to demand-driven inflation, but not respond immediately to supply-driven inflation," Ueda told a lower house confirmation hearing.
"Japan's trend inflation is likely to rise gradually. But it will take some time for inflation to sustainably and stably achieve the BOJ's 2% target," he said.
"It's true there are various side-effects emerging from the stimulus. But the BOJ's current policy is a necessary, appropriate means to achieve 2% inflation."
The yen was volatile through the day and strengthened 0.03% to 134.68 per dollar.
Earlier this month, the government named the 71-year-old academic as its pick to become next central bank governor in a surprise choice that markets initially saw as heightening the chance of an end to the unpopular YCC policy.
With inflation exceeding the BOJ's target, Ueda faces the challenge of phasing out YCC, which has drawn public criticism for distorting market functions and crushing banks' margins.
"There are various possibilities on what YCC could look like in the future," he said, adding that there were side-effects emerging from the policy such as deteriorating market function.
But he said for now, the BOJ needed to monitor whether the measures it took in December, such as widening the band around its yield target, will help ease the side-effects.
Ueda's caution against shifting policy too soon was echoed by Shinichi Uchida, a career central banker and the government's deputy BOJ governor nominee, who said it was inappropriate to tweak ultra-loose policy just to deal with its side-effects.
"The BOJ's current interest rate target levels, including the negative short-term rate, is appropriate. If Japan can foresee inflation reaching 2%, the target levels could be reviewed. But that won't come immediately," Uchida told lawmakers in the same confirmation hearing.
