The Bank of Japan surprised the markets on Tuesday with a sudden adjustment to its controversial policy of yield curve control, in a move that led to huge volatility in the currency, bond and stock markets.
Traders described the move as possibly signaling the long-awaited “pivot” by the Bank of Japan, the last of the world’s major central banks to stick to its ultra-loose regime of avoiding raising interest rates to tackle global inflation.
Japan’s increasingly extreme stance has contributed to a significant decline in the yen this year as markets price in the spread with the US Federal Reserve tightening interest rates.
The central bank said it would allow 10-year bond yields to fluctuate by plus or minus 0.5 percent, instead of the previous 0.25 percent. It kept the overnight interest rate at minus 0.1 percent.
Referring to the deteriorating performance of bond markets, the Bank of Japan said in a statement that it expected the review of the BoJ’s board of directors to “enhance the sustainability of monetary easing.”
Japan’s core inflation – which excludes volatile food prices – has surpassed the Bank of Japan’s 2 percent target for the seventh straight month, hitting a 40-year high of 3.6 percent in October.
But the central bank’s governor, Haruhiko Kuroda, has long argued that any tightening would be premature without strong wage growth, which is why most economists expected the Bank of Japan to stay the course until its ouster in April.
“It may be a generous act by Kuroda to ease the burden on the incoming BOJ governor, but it is a dangerous move and market players feel cheated,” said Masamichi Adachi, chief Japan economist at UBS. “US yields are now falling but if they start to rise again, the Bank of Japan will again face the risk of being pressured to raise interest rates.”
The Bank of Japan’s efforts to defend its YCC goals contributed to the continued decline in market liquidity and what some analysts described as a “glitch” in the Japanese government bond market.
Kyohei Morita, chief Japanese economist at Nomura Securities, said the BoJ’s move was probably seen as a policy adjustment rather than a complete pivot. “The BoJ may want to contribute to minimizing the negative side effects of yield curve control,” he said, noting that the bank’s massive ownership of the Japanese government bond market means that liquidity has evaporated.
“They want to reinvigorate this market, even as the yen appreciates,” Morita said.
The yen briefly jumped nearly 3 percent to about 133 yen against the US dollar, while the stock index Topix fell 2.5 percent and the yield on 10-year notes rose to 0.46 percent, the highest level since 2015. In recent weeks Japan’s currency rebounded from a 32-year low as policymakers in the United States and Europe began to scale back interest rate increases.
Mansoor Mohiuddin, chief economist at the Bank of Singapore, said the BoJ’s move was significant because it indicates the central bank is considering a broader exit from the YCC, adding that it would be an important turning point for the yen.
“The Bank of Japan’s decision to raise interest rates in December 1989 led to a major drastic change in the Japanese markets,” Mohieldin said. Those in charge today will be well aware of this history. It amplifies the importance of their signals to the markets today.”
The BoJ’s move will now lead the market to start pricing in other policy moves, even if none is imminent, said Benjamin Chatel, foreign exchange analyst at JPMorgan.
“This dynamic could set in motion another cycle of higher yields for Japan, testing a new or higher target ceiling for YCC and renewed bouts of yen strength,” Chatel said. “It also has implications for global markets, given the potential for continued asset reallocation for Japanese investors from overseas to domestic bonds — now that they offer a more attractive higher yield.”
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