Bank of Japan loses grip on rates as prices rise, markets bet on bigger pivot

  • BOJ maintains bond yield targets, fee margin remains unchanged
  • BOJ decides to run YCC with ‘more flexibility’
  • Yield class would be ‘references’ rather than ‘rigid limits’
  • BOJ allows 10-year yields to rise by up to 1.0%
  • Ueda said BOJ prevented risk, ready to continue to do so

TOKYO, Jul 28 (Reuters) – The Bank of Japan on Friday announced the start of a slow shift from decades of massive monetary stimulus, allowing the country’s interest rates to rise more freely in line with rising inflation and economic growth.

In what some analysts say could be a seismic shift for global financial markets, the BOJ made its policy of controlling bond yields more flexible and relaxed its defense of a long-term interest rate cap.

Global markets saw the move as Japan aligned with other major central banks, which have tightened aggressive monetary policies to beat skyrocketing inflation, following decades of aggressive stimulus in an effort to restart growth.

While the BOJ kept interest rates at ultra-low levels and stressed the need to continue to support the economy, it said the adjustment to its bond yield curve (YCC) arrangement would allow it to “agilely” respond to risks, including rising price pressures. .

BOJ Governor Kazuo Ueda rejected the view that the move was a step toward policy normalization, instead describing it as a pre-emptive move against the risk of overinflation.

But he also said the bank could adjust policy further if the likelihood of meeting the 2% inflation target sustainably increases, underlining its sharper focus on price pressures.

“It’s an important step towards the eventual dissolution” of YCC, said Tom Nash, portfolio manager at Sydney-based UBS Asset Management.

The BOJ maintained its short-term interest rate target at -0.1% and 10-year government bond yields at around 0%.

It also maintained guidelines that would allow the 10-year rate to move 0.5% around the 0% target, but said these would now be “references” rather than “rigid limits”.

The BOJ said it would offer to buy 10-year Japanese government bonds at 1.0% in fixed-rate transactions, instead of the previous 0.5% rate, indicating it would now tolerate a rise in 10-year rates up to as much as 1.0%.

While some investors had expected a modest change in the BOJ’s guidance, the announcement shocked financial markets that had become accustomed to years of its ultra-conservative policies.

Japanese benchmark bond yields rose to a nine-year high. The yen rose 1.2% to a whopping 138.05 per dollar before weakening 1% to 141.20.

Japanese bank stocks rose 4.6% to an eight-year high on the prospect of a steepening yield curve that would revive loan gains.

The move could also have implications for global money flows and asset price trends, as a cheap yen has been a mainstay of capital market financing for years, with investors borrowing the currency to invest in higher-yielding assets.

While the BOJ left the cap unchanged at ‘about 0.50%’, the subtle language changes suggest they are gearing up for, or at least open to, adjusting the YCC target at some future date, at provided conditions are supportive,” he said. Carlos Casanova, senior Asia economist at UBP in Hong Kong.

Ueda said the BOJ wanted to reduce distortions in bond prices and avoid increasing volatility in the foreign exchange market.

“We would like market forces to drive movements in bond yields more,” Ueda said. “We don’t expect returns to rise to 1%, but have set this cap as a preventative measure.”

Board member Toyoaki Nakamura disagreed, arguing that while making YCC more flexible was desirable, the timing was premature.

The BOJ’s YCC stands for a reckoning


The BOJ’s shift comes after its US and European counterparts hiked rates again, moves that could accelerate the yen’s decline and drive up Japan’s import costs and inflation.

In its quarterly report, the BOJ revised its core consumer inflation forecast for this year from 1.8% in April to 2.5%.

Ueda said the BOJ’s move was partly prompted by a sharp overshoot of this year’s inflation expectations as more companies raised prices and wages.

While price projections for 2024 and 2025 were roughly unchanged from April, risks were on the upside, the central bank said in the report.

“If inflation continues, we will respond appropriately,” Ueda said.

The BOJ’s action highlights the challenge it faces in balancing the risk of higher inflation and the need to continue supporting a budding economic recovery.

While bond markets have been stable recently, the BOJ wanted to avoid another period of volatility that could be caused by higher-than-expected inflation, Ueda said.

Since the introduction of the yield monitoring system in 2016, the bank has had little trouble keeping interest rates under control as inflation remained well below its target. That changed last year when rising 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 widened the yield range last December and now allows 10-year yields to rise by up to 0.5%.

“It’s pretty hard to deal with the side effects when you’re trying to react after upside risks materialize,” Ueda said, adding that the BOJ wanted to avoid a repeat of last December’s bond market turbulence.

Reporting by Leika Kihara; Edited by Sam Holmes, Kim Coghill and Hugh Lawson

Our Standards: The Thomson Reuters Principles of Trust.

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