BOJ strengthens yield control flexibility, cools down on rate cap measures

The Bank of Japan (BOJ) on Friday announced a change in its approach to interest rates in response to increasing signs of inflation and the potential negative effects of prolonged easing.

At the two-day policy meeting that ended on Friday, the central bank kept unchanged its short-term interest rate target at -0.1 percent and that for the 10-year government bond yield around 0 percent.

It also maintained guidance allowing the 10-year yield to move 0.5 percent around the 0 percent target, but said those would now be “references” rather than “rigid limits”.

The BOJ said it would offer to buy 10-year Japanese government bonds (JGB) at 1.0 percent in fixed-rate operations, instead of the previous rate of 0.5 percent, signalling that it would now tolerate a rise in the 10-year yield to as much as 1.0 percent.

These changes in the BOJ’s yield curve control policy reflect the bank’s acknowledgment of evolving economic conditions and its efforts to address inflationary pressures and potential challenges from prolonged easing.

“Sustainable and stable achievement of 2 percent inflation target, accompanied by wage increases, has not yet come into sight,” the BOJ said in a statement announcing the decision, adding that the bank must patiently maintain ultra-loose policy.

“Taking into account extremely high uncertainty on the economic and price outlook, it is appropriate to enhance the sustainability of monetary easing under the current framework by conducting yield curve control with greater flexibility and nimbly responding to upside and downside risks,” it said.

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Following the announcement, the dollar experienced a significant surge against the yen, and the 10-year Japanese Government Bond (JGB) yield rose to 0.55 percent. This marked the highest level seen since September 2014. However, amidst the market response, the Nikkei stock average took a sharp downturn.

“The BOJ will now regard the upper and lower bounds of the 10-year JGB trading range as ‘references, not as rigid limits’, allowing for more flexibility. But the YCC change looks purely technical,” said Carol Kong, currency strategist at Commonwealth Bank of Australia.

“The statement continued to strike a dovish tone with the BOJ still forecasting below-target inflation in fiscal years 2024 and 2025. So, no signal of policy tightening over the forecast horizon.”

Reuters reported that the BOJ’s meeting comes after the Federal Reserve’s decision on Wednesday to raise interest rates, a move that further widens the interest rate gap between the United States and Japan.

Since introducing YCC in 2016, the BOJ had little trouble controlling bond yields when inflation remained well below its target. That changed last year, when soaring commodity prices pushed inflation above the 2% target and gave investors reason to attack the yield cap.

After buying huge amounts of bonds to defend the then 0.25% ceiling, the BOJ last December widened the yield band and now allows the 10-year yield to rise by up to 0.5%.

With wages and inflation rising, markets have been simmering with speculation of an early tweak to YCC.

Data released on Friday showed core consumer inflation in Japan’s capital slowed in July but remained well above the central bank’s 2 percent target, underscoring rising price pressure.