The Bank of Japan (BOJ) has made changes to its yield curve control policy, signaling a potential shift away from massive monetary stimulus. While maintaining ultra-low interest rates, the BOJ has emphasized the need for monetary support and stated that the adjustment to yield curve control (YCC) will allow for more flexibility in responding to risks such as rising inflation. This announcement has caused market volatility, with the yen and yields surging and stocks tumbling. Some investors interpret this as a step towards removing the 0.5% yield cap and preparing for an exit from loose monetary policy.
Although the BOJ has kept the cap unchanged at ‘around 0.50%’, the subtle changes in language suggest a willingness to adjust the YCC target in the future, depending on supportive conditions. This move towards flexibility was seen as desirable by some, but others felt that the timing was premature. At the recent policy meeting, the BOJ maintained its short-term interest rate target at -0.1% and the 10-year government bond yield target around 0%. However, it changed the guidance for the 10-year yield, stating that it would now be a “reference” rather than a “rigid limit.” Additionally, the BOJ announced that it would offer fixed-rate operations to buy 10-year Japanese government bonds (JGB) at 1.0%, indicating a tolerance for a rise in the 10-year yield.
The adjustment to the fixed rate operations effectively widens the 10-year target band, allowing the BOJ to more flexibly guide the yield target. This move has caused the dollar to surge against the yen and the 10-year JGB yield to rise to its highest level since September 2014. The BOJ’s decision comes after the Federal Reserve’s recent interest rate hike, which further widens the interest rate gap between the United States and Japan.
In its quarterly outlook report, the BOJ revised up its core consumer inflation forecast for this year but lowered its forecast for fiscal 2024. The central bank noted that inflation has exceeded its previous projections and that wage growth has accelerated. It also highlighted changes in corporate wage- and price-setting behavior and an increase in price expectations. Given the high uncertainty surrounding the economic and price outlook, the BOJ believes it is appropriate to enhance the sustainability of monetary easing by conducting YCC with greater flexibility.
Since implementing YCC in 2016, the BOJ has faced challenges in controlling bond yields as inflation exceeded its target. Last year, the BOJ widened the yield band in response to soaring commodity prices and allowed the 10-year yield to rise by up to 0.5%. With wages and inflation on the rise, there has been speculation about an early adjustment to YCC. Recent data shows that core consumer inflation in Japan’s capital has slowed but remains above the BOJ’s 2% target, highlighting increasing price pressure.
Overall, the BOJ’s decision to make its yield curve control policy more flexible and loosen its defense of the long-term interest rate cap is seen as a potential precursor to a shift away from massive monetary stimulus. The market reaction has been volatile, with the yen and yields surging and stocks tumbling. The BOJ’s meeting follows the Federal Reserve’s interest rate hike, which has widened the interest rate gap between the United States and Japan. The BOJ’s quarterly outlook report also indicates heightened inflation expectations and the need for greater flexibility in conducting YCC.
