The Bank of Japan left its key interest rates unchanged while announcing policy tweaks, including a shift in purchases of exchange-traded funds toward assets linked to the Topix equities index and flexibility in bond operations.

The central bank will also reduce the amount of bank reserves subject to its negative interest rate, it said in a statement on Tuesday. The BOJ also added forward guidance for policy rates in its statement today, stating that it intends to maintain the current extremely low levels of short- and long-term interest rates for an "extended period of time."

In relation to the long-term rate, the BOJ reiterated that it will buy JGBs to keep the 10-year yield at about zero per cent, but added language stating that "while doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices."

The BOJ cut its inflation forecasts, indicating it is preparing for an even longer road to 2 percent price gains, further widening the gap with its global peers, who are moving away from crisis-era policies.

ETF Shift

The central bank said it would shift its allocation of ETF purchases further toward Topix-linked products and away from those linked to the Nikkei 225 Stock Average. The distorting effects of the central bank’s buying of old blue-chip gauge has come under criticism from market participants.

The central bank said it now sees core consumer prices rising 1.5 per cent in the 2019 fiscal year, down from 1.8 per cent. The BOJ also lowered its forecast for fiscal 2018 to 1.1 per cent, down from 1.3 per cent. For fiscal 2020, it predicted 1.6 per cent, down from 1.8 per cent.

The new forecasts show the BOJ’s struggle to stoke inflation even after five years of the world’s most aggressive monetary stimulus. The Federal Reserve last month raised interest rates for a sixth time in 18 months and set a steeper rate-hike trajectory, while the European Central Bank has plotted the end of its asset purchases this year.

Stay the Course

Governor Haruhiko Kuroda has emphasized the need to stay the course with stimulus. Following the new forecasts, he is certain to face questions about price momentum and policy sustainability during his news conference later on Tuesday.

He said in June, when the BOJ also cut its current assessment of inflation, that the central bank would look more closely at the reasons inflation isn’t picking up as expected. Though slightly improved, core inflation, which excludes fresh food, reached only 0.8 per cent in June.

In fact, with inflation stalling, news reports in recent weeks said the central bank would prepare for a longer battle by debating ways to make stimulus more sustainable, including by mitigating the side effects.

Jittery Markets

The market reaction to those reports showed the risks the BOJ faces in taking any steps that might be interpreted as normalizing policy. Last week, reports of potential policy changes pushed up the 10-year yield to near a level seen as the upper limit of the BOJ’s accepted range. This prompted the central bank to step in with offers of unlimited, fixed-rate purchases of government bonds.

While economists maintained their stance that the central bank was unlikely to take action at this meeting, some said the news reports, which cited unidentified BOJ officials, were signaling that action would be taken in coming months.

The BOJ had previously downplayed the side effects of its policy, saying banks and markets were functioning at acceptable levels. It has insisted the yield-curve control program is highly sustainable, while pledging to closely monitor its side effects.