The Bank of Japan stuns the markets by changing its yield control policy

The Bank of Japan surprised the markets on Tuesday with an unexpected change in its controversial yield curve control policy, which 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 leading central banks to stick to a very loose regime to avoid raising interest rates to tackle global inflation.

“We consider this decision a big surprise, as we expected any expansion of the acceptable range under the new leadership of the Bank of Japan from spring next year, similar to the market,” said Naohiko Baba, chief economist for Japan at Goldman Sachs.

But at a press conference, Bank of Japan Governor Haruhiko Kuroda denied that the latest adjustment amounted to a tightening of monetary policy, stressing that the central bank would not abandon its yield target.

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.

Kuroda had said earlier that any adjustment to yield curve control (YCC) would effectively amount to an interest rate increase. But he said on Tuesday that the amendment was aimed at addressing increased volatility in global financial markets and improving the performance of the bond market to “enhance the sustainability of monetary easing”.

“This measure is not a rate hike,” Kuroda said. “The YCC adjustment does not indicate the end of the YCC or an exit strategy.”

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 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 continue on course until it steps down in April. On Tuesday, the Bank of Japan maintained its forecast that inflation will slow next year and warned of “extremely high uncertainty” for the economy.

“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. The central bank now owns more than half of the bonds outstanding, compared to 11.5 percent when Kuroda became governor in March 2013.

Line chart of the daily change in the 10-year Japanese government bond yield showing the Bank of Japan shaking the bond market out of its slumber

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, The Japanese currency rebounded from a 32-year low as policymakers in the United States and Europe began to scale back interest rate increases.

The Bank of Japan’s move on Tuesday also rebounded in other large markets. The 10-year US Treasury yield rose 0.08 percentage point to 3.66 percent, while the equivalent British Treasury yield rose by the same margin to 3.58 percent. Yields go up when prices go down.

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 Bank of Japan’s move will now lead the market to start pricing in other policy moves, even if none is forthcoming, said Benjamin Chatel, foreign exchange strategist 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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