Bank of Japan may maintain low rates, discuss adjusting yield cap

Bank of Japan may maintain low rates, discuss adjusting yield cap

The Bank of Japan and Prospects of Sustained Inflation

The Bank of Japan (BOJ) is set to keep ultra-low interest rates with the possibility of making minor tweaks to extend the lifespan of its yield control policy. This move comes as the policy faces scrutiny given the prospects of sustained inflation. Under the yield curve control (YCC) policy, the BOJ guides the 10-year bond yield around 0% and sets an allowance band of 0.5% above and below that target.

Despite inflation holding above the BOJ’s 2% target for over a year, Governor Kazuo Ueda has committed to maintaining an ultra-loose policy until he is more confident in the economy’s ability to withstand global headwinds and support wage increases in the coming year. The central bank is expected to maintain the 10-year yield target at 0.5% and a -0.1% target for short-term interest rates.

The Nikkei newspaper reported that the BOJ may discuss allowing long-term interest rates to rise above the 0.5% cap for the 10-year government bond yield by a certain degree. This adjustment aims to address market distortions caused by the BOJ’s heavy bond buying. The report suggests that the BOJ will also implement measures to prevent any abrupt increase in long-term rates. The news of potential changes caused the dollar to weaken against the yen, with a trade around 139.82.

Since the introduction of YCC in 2016, the BOJ has successfully controlled bond yields when inflation remained below its target. However, last year’s surge in commodity prices pushed inflation above 2%, prompting investors to challenge the yield cap. To defend the 0.25% ceiling, the BOJ purchased significant amounts of bonds, leading to the widening of the yield band in December. Presently, the BOJ allows the 10-year yield to rise by up to 0.5%.

The potential adjustments to the YCC policy are also influenced by the widening interest rate gap between the United States and Japan. The Federal Reserve’s recent decision to raise interest rates exacerbates this gap. Addressing any further decreases in the yen becomes essential to prevent potential negative consequences, such as increased costs of food and fuel imports for households and retailers.

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BOJ Deputy Governor Shinichi Uchida’s acknowledgment of the side effects of YCC, such as impacts on market function, further fueled speculation about possible changes in the policy. While wages and inflation are on the rise, there is widespread speculation that Governor Kazuo Ueda may gradually phase out the previous administration’s radical stimulus program.

The BOJ’s meeting coincides with the Federal Reserve’s decision to raise interest rates, widening the gap between US and Japanese interest rates. The outcome of the BOJ meeting and any tweaks to the YCC policy could impact the yen’s value. Investors and market participants will closely observe the central bank’s announcement and Governor Ueda’s subsequent news conference.

The BOJ’s quarterly growth and outlook report, set to be released after the policy meeting, will provide insights into the central bankers’ confidence regarding sustained inflation. While the board is expected to upgrade its inflation forecast for the current fiscal year from the current projection of 1.8%, projections for fiscal years 2024 and 2025 are likely to remain largely unchanged due to uncertainty surrounding global economic growth.

In conclusion, the Bank of Japan faces the challenge of maintaining ultra-low interest rates despite the prospects of sustained inflation. Possible tweaks to the BOJ’s yield control policy aim to address market distortions and prevent further declines in the yen. The outcome of the BOJ meeting and the subsequent announcements will provide valuable insights into the central bank’s stance on inflation and its commitment to economic stability.

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