Japan PM Gets Inflation Goal; Next on List, A New BOJ Governor

Bank of Japan headquarters in Tokyo, Japan
Tomohiro Ohsumi | Bloomberg | Getty Images
Bank of Japan headquarters in Tokyo, Japan

After pressuring Japan's central bank into overhauling monetary policy, Prime Minister Shinzo Abe declared the change "epoch making". Next on his to-do list: find a central bank chief more sympathetic to his views than the current governor.

In its most determined effort yet to end years of economic stagnation, the Bank of Japan said on Tuesday it would switch to an open-ended commitment to buying assets next year and double its inflation target to 2 percent.

It issued a joint statement with the government promising to reach the inflation goal "at the earliest possible time," drawing praise from Abe who had piled relentless pressure on the central bank to take bolder measures to pull Japan out of deflation and recession.

Although the scale of the measures was greater than markets had expected, investors were disappointed the open-ended buying, similar to a U.S. Federal Reserve policy, would not begin until 2014. That suggested no extra stimulus measures this year.

But Bernd Berg, global currency strategist at Credit Suisse, suggested markets would soon switch their focus to the next stage of Abe's plan and that would keep the yen on a weakening path, a trend that has bolstered the stock market.

(Read More: Further Yen Weakness Unlikely: Japan's 'Mr Yen')

"The general upward move in dollar/yen will continue due to expectations of more easing after a new BOJ governor is appointed in April," he said.

Abe led his Liberal Democratic Party to a landslide victory in December elections and his campaign for aggressive budget and monetary stimulus had pushed the yen lower and sparked a stock market rally on hopes a weaker currency would boost exports. He hailed Tuesday's BOJ action as a game-changer.

"It is 'epoch-making' in a sense of a bold review of monetary policy," he told reporters.

Masaaki Shirakawa's term as central bank governor ends in just over two months. He has faced persistent pressure from lawmakers to do more with monetary policy to lift the economy as recent governments steadily built up massive debts, limiting the room for fiscal expansion.

But he has resisted, insisting monetary policy alone can only have a limited impact against the deflation that has come to define just over a decade of economic stagnation in Japan.

Pumping unlimited amounts of cash into the banking system or underwriting government debt, solutions pushed by critics, could thrust Japan into a financial crisis, he has maintained.

(Read More: Is the 'Abe Trade' in Danger of Unwinding?)

Many analysts expect Abe to pressure the BOJ for yet more action, especially in the run-up to upper house elections expected in July.

The 2 percent inflation target gives him the stick he can use to beat the BOJ for more policy easing. Japan has only achieved 2 percent inflation in a handful of months since the late 1990s.

"If this means they always need to do something until inflation rises to 2 percent, they would need to ease every month," said Katsutoshi Inadome, fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities.

More Action Expected

Abe has made clear that he wants a BOJ governor who shares his push to reflate the economy with a hyper-easy monetary policy combined with big fiscal spending.

Such a job would suit Toshiro Muto, a former finance ministry official and former deputy governor at the BOJ, said Isao Iijima, a political strategist for Abe.

Experience at the Finance Ministry's budget bureau and strong connections in the world of finance and politics will be vital for the next BOJ governor, Iijima said.

"That's why, if I'm to be honest, I think that a former finance ministry official would be best," he told Reuters. "For example, Muto."

Kazumasa Iwata, a former government economist who served as deputy BOJ governor until 2008, has also been mooted as a possible Shirakawa replacement.

He has consistently called for bolder monetary stimulus to beat deflation.

The next policy options include scrapping the 0.1 percent floor the BOJ sets for short-term interest rates to encourage more lending and the central bank buying longer-duration bonds.

(Read More: Can the Bank of Japan Deliver on Its Bold Promise?)

"I think the BOJ and the next governor after Shirakawa are likely to be asked or expected to hammer out bolder measures," said Mitsushige Akino, executive director and chief fund manager at Ichiyoshi Asset Management in Tokyo.

Analysts generally agree BOJ action alone won't reinflate the economy. For its part, the cabinet this month approved about $117 billion of spending in Japan's biggest stimulus since the global financial crisis.

But many economists say the combined measures will provide only a temporary boost unless the government follows through with politically more difficult economic reforms such as deregulating its protected farming sector.