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The Bank of Japan has taken a significant step to end its seven-year policy of capping long-term interest rates, setting the stage for a gradual unwinding of massive monetary easing measures as it sharply raised its inflation outlook.
The BoJ’s policy board on Tuesday announced a near-unanimous decision to allow yields on the 10-year Japanese government bond to rise above 1 per cent, revising its so-called yield curve control policy for the second time in three months.
The bank said the 1 per cent ceiling on 10-year yields would be regarded as “a reference”, noting that strictly capping long-term interest rates could entail “large side effects”. The BoJ previously said it would offer to buy 10-year bonds at 1 per cent in fixed-rate operations, after raising the cap from 0.5 per cent in July.
BoJ governor Kazuo Ueda said the board wanted to make the controls on the bond market more flexible as a pre-emptive step to avoid future volatility in financial markets, including currencies.
“In July, we did not think that the [10-year JGB] yields would approach 1 per cent so quickly,” Ueda said at a news conference on Tuesday. “The biggest factor behind this is the bigger than expected rise in US Treasury yields.”
The decision marked one of the BoJ’s biggest steps towards exiting its long-running experiment with ultra-loose monetary policy, as the weakening yen, rising bond yields and persistent inflation put pressure on Ueda to begin unwinding core parts of its accommodative stance.
The central bank maintained its policy rate at minus 0.1 per cent, the world’s only negative interest rate. But it also significantly revised its inflation forecast upward, saying it expected 2.8 per cent core inflation in the 2024 fiscal year, instead of its previous forecast of 1.9 per cent.
“In its final phase, the YCC seems to have become more of a dead letter,” said Hiroshi Miyazaki, senior economist at Mizuho Research & Technologies. “Investors will question the BoJ’s stance that it will patiently continue with monetary easing, so they will expect the next step such as the lifting of negative interest rates to happen more quickly.”
Price growth in Japan has been more persistent than expected this year, with annual inflation at 4.2 per cent in September, excluding energy and fresh food prices.
Ueda has argued that the main factor pushing up prices is a rise in import costs and that the central bank needs to wait for more sustainable signs of wage growth to ensure the economy does not fall back into decades of deflation.
On Tuesday, Ueda acknowledged that the BoJ was more likely to hit its 2 per cent inflation target on a sustainable basis. “But we have not yet reached a situation where we can be fully confident,” he said.
The growing gap between borrowing costs in Japan and those of the US and Europe — especially after 10-year US Treasury yields surged to their highest levels in 16 years this month — has forced the BoJ to repeatedly make large JGB purchases to keep yields below its 1 per cent ceiling.
Ahead of Tuesday’s decision, the yen touched new lows against the dollar as hedge funds tested Japanese authorities’ willingness to intervene to defend the currency.
Foreign exchange analysts said the main takeaway for currency markets was that the BoJ was attempting to weaken the YCC cap and remove a “target” for the market.
“The ultimate objective is to engineer an exit from YCC without explicitly telling the market they are doing so — it will be feeling in the dark to test how far above reference range we can get — but the direction of travel is clear,” said Benjamin Shatil, foreign exchange strategist at JPMorgan.
The yield on 10-year JGBs hit 0.941 per cent, after having risen to as much as 0.957 per cent in morning trading ahead of the announcement, its highest level since June 2013.
The yen fell as much as 0.9 per cent against the dollar to a low of ¥150.41. The Japanese currency is down about 12.8 per cent against the dollar this year.
Additional reporting by Hudson Lockett and William Langley in Hong Kong
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