DJ: BOJ Morimoto Urges Fiscal Overhaul to Avoid Blunting of Policy Tools

KOCHI, Japan--A senior Bank of Japan policy maker on Wednesday urged the government to put its battered fiscal house in order, warning that central bank monetary easing won't produce the desired effects if worries over public finances push up borrowing costs.

The remarks by Yoshihisa Morimoto, one of the bank's nine policy board members, comes amid growing signs that the BOJ is leaning toward buying longer-term Japanese government bonds as part of its asset-purchase program, a step some analysts say could backfire if the government fails to implement fiscal reforms at the same time.

"The Bank of Japan will carry on with strong monetary easing, including large-scale purchases of government securities," Mr. Morimoto told business leaders in the city of Kochi in Shikoku, southwest Japan.

But "our country's finances stand out in the world for their extremely severe condition," he said. "If confidence in the nation's public finances is shaken, interest rates will rise, making fiscal management even more challenging and possibly undermining the impact of monetary easing."

"For monetary easing to have its full effect," Mr. Morimoto said, "it is important to retain market confidence in efforts to bring the fiscal state back to health."

Mr. Morimoto's comments suggest lingering concerns inside the central bank over Prime Minister Shinzo Abe's "three-arrow" strategy of monetary easing, fiscal spending and growth-boosting measures to tackle deflation and reinvigorate the economy.

At more than 200% of the nation's annual economic output, Japan's public liabilities are among the largest in the world--and they are still expanding. If a combination of aggressive monetary easing and fiscal spending raises suspicions that Japan might be trying to reduce the value of its debt by inflating the economy, investors in JGBs may demand higher interest rates to compensate for those risks, analysts say. Higher yields on government debt usually translate into even higher borrowing costs for businesses and consumers.

But a prevalent view in the market is that the central bank has no choice but to keep easing its policy because of a 2% inflation target it adopted in January, a high hurdle for a Japanese economy still in the thrall of deflation. Signaling the BOJ's readiness to act again in the future, Mr. Morimoto said the bank will take "appropriate steps at the right time."

BOJ meeting minutes released Tuesday revealed that some board members said during the bank's January meeting that one "option" would be for the central bank to extend the maximum maturity of JGBs the BOJ buys to around five years from the current three years.

While traders have long expected the bank to move in that direction, BOJ officials have been worried that doing so could spark market suspicions that it is "monetizing" public debt, often considered a recipe for high inflation.

On a more positive note, Mr. Morimoto said he expects Japan's economy will return to a "moderate recovery path" toward the middle of this year. The yen's recent decline is expected to underpin Japanese exports and corporate profits, he added.