Financial Times – July 28, 2023
The Bank of Japan has eased controls on its government bond market, altering a cornerstone of its ultra-loose monetary policy and prompting a surge in the country’s benchmark bond yields to the highest level in nine years.
In an unexpected move, the BoJ said it would offer to buy 10-year Japanese government bonds at 1 per cent in fixed-rate operations, in effect widening the trading band on long-term yields. The central bank added that it was technically maintaining its previous 0.5 per cent cap on 10-year bond yields, but this level would be a “reference” rather than a “rigid limit”.
The move triggered confusion about whether the central bank would make further moves to unwind its easing policy, which has come under pressure this year from inflation that has hit four-decade highs. But the BoJ held its overnight rate at minus 0.1 per cent, saying more time was needed to sustainably achieve its 2 per cent inflation target.
Kazuo Ueda, the BoJ governor who took over in April, said in a briefing on Friday that the central bank was “not ready” to allow yields to move freely, arguing this would amount to abandoning the bank’s longstanding bond-buying policy of depressing yields, known as yield curve control.
The 10-year JGB yield rose to as much as 0.572 per cent following the BoJ announcement, the highest level in almost nine years. Japan’s yen fluctuated, briefly falling as much as 1 per cent against the dollar before reversing course to be up 1 per cent and then turning again to be flat at ¥139.58. The benchmark Topix stock index fell as much as 1 per cent before paring losses to close down 0.2 per cent, although a banking sub-index rose 4.5 per cent.
Japan is the only country in the world with negative interest rates. But rate rises by the US Federal Reserve and the European Central Bank, compounded by inflation that has proven more widespread and resilient than anticipated, have put pressure on the BoJ’s ultra-loose policy stance.
Headline inflation in Japan rose to 3.3 per cent in June, outpacing US price rises for the first time in eight years.
Ueda has argued that price rises are not being driven by strong underlying consumer demand and will slow as the cost of imported commodities falls. After struggling to lift the economy out of deflation for most of the past three decades, BoJ officials are cautious about unrolling easing measures without firmer evidence of rising wages.
The BoJ governor said introducing “greater flexibility” into the central bank’s yield curve controls was a “pre-emptive” measure to address inflation risks and allow market forces to drive bond yield pricing while “enhancing the sustainability of our easing framework”.
“We expanded the room to address upside risks, but we also cannot ignore the downside risks,” Ueda added. The BoJ on Friday upgraded its inflation outlook for fiscal 2023 from 1.8 to 2.5 per cent while warning of upside risks to its fiscal 2024 forecast of 1.9 per cent.
But analysts questioned the BoJ’s logic and warned that the latest change would invite investors to test the bank’s resolve.
Ayako Fujita, chief Japan economist at JPMorgan, said the BoJ resorted to a complicated method to tweak its policy to buy time until markets digested the move: “It shows that the BoJ really did not want to be seen as heading towards policy normalisation. But in hindsight, it would probably be interpreted as a step in that direction.”
Ueda added that the central bank would “not tolerate” the 10-year yield exceeding 1 per cent and would “step in” with bond buying if it did.
Tetsuya Inoue, a former BoJ official who is now a senior researcher at Nomura Research Institute, said the move was akin to policy tightening. “It would have had the same effect if they had ended YCC and said they would intervene in markets when volatility rose,” he said.
The central bank stunned economists in December when it altered its yield curve control policy, widening the band from a quarter to half a percentage point. JGB yields surged to the highest level in two decades, forcing the BoJ to spend billions to defend its target range.
“Rightly or wrongly, market participants will conclude that this marks the beginning of the end for YCC,” said Benjamin Shatil, FX strategist at JPMorgan in Tokyo. “The immediate implication is that the BoJ has allowed for more flexibility in domestic yields; but whether this also translates into a risk of higher market volatility will need to be closely watched.”