It happened so quickly.

While analysts and economists had long debated the efficacy ofquantitative easing — the central bank bond purchase programsaimed at lowering borrowing costs to stimulate the economy andstoke inflation — the narrative surrounding such efforts is rapidlyshifting. In recent months, there's been a growing recognitionof the limits and downsides to this particular form of monetaryeasing, underscored by the Bank of Japan's policy changes announced onWednesday.

Some 15 years after first experimenting with QE, the BOJannounced that it intends to shift the focus of its policyframework to better finesse borrowing costs by, ineffect, anchoring longer-term rates higher, and moving away from arigid target for expanding the money supply. While marketparticipants expect the central bank to further expand bondpurchases and take the rate on a portion of bank balances deeperinto negative territory in upcoming meetings, the BOJ's move is arecognition that its daring strategy to dramatically expand themoney supply to fight deflation has delivered a blow to thefinancial sector's profitability.

“The biggest takeaway here is that the BOJ is now leading theworld into a new era of central banking and is essentially makinglong-term interest rate, 10-year Japanese governmentbond yields a focal point in its central banking platforminstead of negative interest rate policy,” analysts at TDSecurities Inc. led by Mazen Issa, wrote in a note today. “Theyield curve control program is an interesting but untested concept.It is one attempt to provide relief for pension funds, [lifeinsurance companies], and banks.”

The program announced on Wednesday helped propel Japaneselenders' stocks higher, underscoring the evolution in easy monetarypolicy. The BOJ plans to buy enough 10-year government bonds tokeep the yield close to zero percent, while potentially purchasingfewer longer-dated bonds, in a move expected to boost profits forthe financial sector and encourage them to lend and invest.

The Bank of Japan had doubled-down on its QE program in Februarywith the surprise introduction of a negative interest-rate policyon a portion of bank reserves, sharply lowering long-term rates —as well as bank stock prices — amid a squeeze on net interestmargins for lenders.

Despite the shock-and-awe strategy early in the year, the yenappreciated in the aftermath of the move, while deflation riskremains unabated — with CPI at minus 0.5% year-on-year in July —and long-term inflation expectations remain stubbornly low.

Though the BOJ has maintained the minus 0.1% charge on somebank balances, its yield-curve commitment — similarly deployedby the Federal Reserve from 1942 to 1951to lower the U.S. Treasury's post-war financing costs, but whichremains unprecedented in modern times — represents a sea-change inthe central bank's thinking.

The BOJ's newfound embrace of a yield-curve target is a belatedrecognition that NIRP can negatively impact financialintermediation and inflation expectations, say analysts.

“The good news is that BOJ has finally acknowledged that NIRPdoes have some negative impact on intermediation and potentially oninflation expectations – which the BoJ puts at the center of itspolicy goal,” Morgan Stanley economists led by Takeshi Yamaguchiwrote in research published last week, for instance. “The fear isthat this negative impact will wax and positive impact wane. Oncethe evidence is clear, the result may already have had seriousadverse consequence for the real economy.”

Hans Redeker, strategist at the U.S. bank, reckons anegative-yielding flat yield curve has reduced monetary velocityand pushed the yen higher, while a steeper yield curve — allowingfinancial intermediaries to borrow at low rates and invest atlonger maturities — might unleash the animal spirits neededto increase risk-taking.

In a report last week, amid indications from officials that theBOJ would anchor long-end yields higher, Redeker wrote: “Financialsector balance sheets have been dismissed by central banks for toolong,” adding that the central bank's newfound focus onfinancial-sector profitability represents a belated recognition ofbanks in aiding the transmission of monetary policy to the realeconomy.

Tomoya Masanao, head of Japanese portfolio management at PacificInvestment Management Co LLC, in a research note last week, called on theBOJ to scale back JGB purchases at the long-end to steepen theyield curve and aid financial intermediation, arguing that negativelong-end rates had facilitated the refinancing of existing debtrather than stimulating new productive investments.

Bankers argue low longer-dated yields and negative rates delivera blow to their return on assets, offsetting the benefits of lowerfunding costs — and the BOJ's apparent capitulation mightembolden critics of monetary policy in other advancedeconomies.

Questions over the effects of QE have already extended away frompolicymakers at the BOJ. In the U.K., Monetary PolicyCommittee Member Kristin Forbes suggested in the aftermath of the Brexitreferendum that further easing could end up tighteningfinancial conditions rather than loosening them.

“People will earn less on their hard-earned savings —potentially cutting back on spending to reach a target savings pot.Banks will make less money on lending,” she wrote in an op-ed.“Pension and life insurance funds will have a harder time meetingtheir commitments. Companies may need to put more money intopension schemes — leaving less to spend on workers andinvestment.”

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