Bank of Japan to permit 10-year yields to exceed 1%

01 Nov, 2023

Bank of Japan to permit 10-year yields to exceed 1%

In a significant shift, the Bank of Japan has modified its yield curve control (YCC) policy, now allowing 10-year Japanese government bond (JGB) yields to exceed 1%. This decision comes in response to rising inflationary pressures and concerns regarding market stability.

The YCC policy, which entails the central bank's strategy of purchasing government bonds to regulate interest rates, has been a long-standing practice. Since July, the Bank had capped long-term interest rates at 1%, a notable increase from the previous ceiling of 0.5%. This adjustment aims to address inflation-related challenges and manage market volatility.

BOJ Governor Kazuo Ueda emphasized that increasing flexibility within the YCC policy is essential to mitigate potential side effects in future financial markets. This policy shift offers greater maneuverability in shaping long-term interest rates in response to evolving economic conditions.

The 10-year JGB yields, which had hovered below 0.9% earlier, reached as high as 0.957% following the announcement. Ueda explained that the move was intended to act preemptively, preventing yields from reaching the 1% cap and causing unintended side effects.

The Bank of Japan has long grappled with the challenge of achieving its target of stable 2% inflation, which has been consistently exceeded for 11 consecutive months. The Bank remains committed to the YCC policy as long as it is necessary to maintain this inflation target.

While eight members of the nine-member policy board supported this decision, Toyoaki Nakamura dissented, suggesting that the central bank should wait until companies' earning power strengthens.

The YCC policy, often referred to as ultra-easy, has set the Bank of Japan apart from other major central banks in terms of interest rate policies. This approach has drawn criticism for creating market distortions and weakening the yen.

Diverging interest rate trends between Japan and other markets have led to a decline in the yen's value, reducing overseas purchasing power. To address these concerns, the Bank of Japan also revised its inflation forecasts and released its quarterly economic outlook.

Experts such as Jason Wong, a senior markets strategist for the Bank of New Zealand, believe that these policy adjustments were long overdue. They argue that the BOJ's monetary policy has remained excessively accommodative despite rising inflation and tightened policies in the developed world.

The depreciation of the yen, while advantageous for inbound tourists, has posed challenges for workers facing slow wage growth and increased import costs. Wong noted that the Finance Ministry has grown uneasy with the weakening yen, and he suggested that a change in the YCC policy stance could strengthen the currency.

BOJ officials emphasize the importance of currency stability and have refrained from making overt statements regarding intervention to avoid disrupting markets. However, recent policy shifts suggest that Governor Ueda is gradually moving away from the previous policy stance, seeking consistency and carefully chosen words in his communication.

As the year progresses, the focus remains on wage negotiations and developments in the exchange rate, with Ueda underscoring the importance of establishing a positive feedback loop between wage increases and rising prices.

The recent policy adjustment signifies a shift from the previous policy under Haruhiko Kuroda, and it reflects Ueda's efforts to convey a sense of continuity and consistency in the Bank's approach. While hints of policy changes have arisen, Ueda remains cautious in revealing specific timelines or directions for such shifts. The two-day policy meeting concluded with this decision, marking one of the penultimate meetings for 2023.