By Leika Kihara

TOKYO, Reuters – While the Bank of Japan is facing a problem in Ukraine, it has to keep a more dovish stance regarding monetary policy despite increasing inflation and a lack of resources to counter another economic downturn.

Japan, unlike other advanced countries, is still bound by COVID-19 restrictions that delay an economic recovery following the pandemic. Growth has been slowing in this quarter.

Japan is facing a severe economic crisis due to the recent increase in oil and grain costs in response to Russia’s invasion Ukraine. A projected slowdown of global growth could also threaten its export-dependent economy.

According to four people familiar with the BOJ’s thinking, this means that inflation will approach, or exceed, its 2% target over coming months. However, it will have to be refocused on economic risks – something policymakers are currently discussing.

Rising fuel costs are a source of concern. One source stated that “it’s a big risk for Japan’s economic growth which may push down growth in this year.”

Another source stated that the BOJ’s immediate focus is on economic damage, so it doesn’t have any reason to stop stimulus, even if inflation temporarily hits its target.

MONETARY POLICY “POWERLESS”

As the Federal Reserve, other central banks and major financial institutions are aiming to raise interest rates in an effort to slow inflation, BOJ’s cautious stance is an anomaly.

Many policymakers are reminded of Japan’s 2008 situation, which saw core consumer inflation exceeding 2% three months ago due to rising commodity and energy prices. Before the global collapse of Lehman Brothers, stagnation was a result of the household burden.

This time, the BOJ is without any effective tools to support growth. It must fight against global central banks that are reducing crisis-mode stimulative measures.

Even more complicated is the BOJ’s situation.

Core consumer inflation will approach 2% in April according to analysts, after the effects of phone-fee cuts (which kept inflation at 0.2% January) dissipate.

Consumer inflation could remain at 2% longer than 2008, when it fell to zero within three months. This is despite the fact that prices for many materials are on the rise and the weakening yen driving up import costs.

The government subsidizing fuel may slow down the rising tide, but SMBC Nikko Securities predicts that core consumer inflation will be 2.4% by April and 2% through the remainder of 2011.

Japan’s uncertainty about the future may allow Japanese companies to skip wage increases, which could impact consumption because households reduce spending in order to meet rising living expenses.

Yoshiki Shinke (chief economist, Dai-ichi Life Research Institute) stated that “there’s nothing to be cheered about inflation reaching its target.” “If inflation is at or near 2%, households will lose their sense of security and increase consumption.

Contrary to its peer banks, who can slow down or stop hikes when Ukraine hits growth in its economy, the BOJ doesn’t have any levers with interest rates lower than zero and its vast asset-buying programme at its maximum.

Its current short-term rate goal is at -0.1%. That’s a lot lower than the +0.5% it had in 2008.

Rising risks for growth might encourage doves on the BOJ board to ramp up their stimulus, but they are also cautious due to rising costs and decreasing returns of prolonged easing.

An era of massive asset purchases failed to raise inflation to 2%. Bank margins were crushed by ultra-low interest rates, which forced the BOJ into a series of actions to alleviate their stress.

BOJ data revealed that domestic banks earned 0.65% on new loans last December, after a peak of 1.80% in 2007.

According to a BOJ Report released September, regional banks won’t likely be able cover operating profits with credit costs if there is another Lehman Crisis-like shock.

Analysts warn that this could mean banks may be unable to weather market turmoil if they increase negative rates.

Nobuyasu Asago (ex-BOJ official, now chief economist of Ichiyoshi Securities) stated, “Monetary Policy is not powerless to manage situations like this, when inflation is spiking more based on supply factors then strong demand.”

The BOJ cannot tighten its policy, but it can ease. It has exhausted all of its resources and can’t do much.