The Bank of Japan stunned markets on Tuesday with a surprise adjustment to its controversial yield curve management policy, in a move that triggered wide swings in currency, bond and stock markets.
Traders described the move as potentially marking the long-awaited “pivot” by the BoJ, which is the last of the world’s major central banks to stick to its ultra-loose regime to avoid raising interest rates to tackle global inflation.
Japan’s increasingly extreme outlier status has contributed to a huge fall in the yen this year as markets have priced in the difference with the rate-tightening US Federal Reserve.
The central bank said it would let 1[ads1]0-year bond yields fluctuate by plus or minus 0.5 percent, instead of the previous 0.25 percent. It kept overnight interest rates at minus 0.1 percent.
Noting that the functioning of bond markets had deteriorated, the BoJ said in a statement that it expected the revision of the YCC to “strengthen the sustainability of monetary easing.”
Japan’s core inflation – which excludes volatile food prices – has exceeded the BoJ’s 2 percent target for the seventh consecutive month, hitting a 40-year high of 3.6 percent in October.
But the central bank’s governor, Haruhiko Kuroda, had long argued that any tightening would be premature without robust wage growth, which is why most economists had expected the BoJ to stay the course until he stepped down in April.
“Perhaps it is an act of generosity by Kuroda to reduce the burden on the next BoJ governor, but it is a dangerous move and market participants feel cheated,” said UBS Japan chief economist Masamichi Adachi. “US interest rates are now falling, but if they start to rise again, the BoJ will again face the risk of being pressured to raise interest rates.”
The BoJ’s efforts to defend its YCC targets have contributed to a sustained reduction in market liquidity and what some analysts have described as “dysfunction” in the Japanese government bond market.
Kyohei Morita, Japan’s chief economist at Nomura Securities, said the BoJ’s move was probably best seen as a policy adjustment rather than a full pivot. “Probably the BoJ wants to help reduce the negative side effects of the yield curve control policy,” he said, noting that the bank’s outsized ownership in the Japanese government bond market meant liquidity had evaporated.
“They want to reactivate that market, even at the cost of yen appreciation,” Morita said.
The yen briefly jumped nearly 3 percent to around 133 yen against the U.S. dollar, while the Topix stock index fell as much as 2.5 percent and the yield on the 10-year bond rose to 0.46 percent, the highest since 2015. in recent weeks the Japanese currency has recovered from a 32-year low as policymakers in the US and Europe have begun to scale back the size of rate hikes.
Bank of Singapore chief economist Mansoor Mohi-uddin said the BoJ’s move was significant because it signaled the central bank is considering a broader exit from the YCC, adding that it would be an important turning point for the yen.
“The BoJ decision to raise interest rates in December 1989 led to a major change in Japanese markets,” Mohi-Uddin said. “Today’s officials will be well aware of that history. It reinforces the importance of their signal to the markets today.”
JPMorgan currency strategist Benjamin Shatil said the BoJ’s move now would cause the market to start pricing in further policy moves, even if none actually comes.
“These dynamics could start a new cycle of higher Japan yields, testing of the new or higher YCC target and renewed bouts of yen strength,” Shatil said. “It also has implications for global markets, given the potential for continued asset reallocation by Japanese investors from foreign bonds back to domestic bonds – now that they offer a more attractive higher yield.”