As increasing inflation puts the Bank of Japan’s (BOJ) ultra-easy monetary policy under pressure, the markets are trying to test the BOJ’s willingness to control bond yields as early as its policy choice on Wednesday.
Here are some potential changes the BOJ might make to its yield curve control (YCC) strategy, which seeks a 10-year govt bond yield in the vicinity of zero and charges some money parked with the institution a rate of minus 0.1%.
The BOJ’s decision to broaden the range around its target 10-year yield last month did not succeed in correcting the market distortions brought on by its massive bond purchases; instead, it caused the market to challenge the range’s 0.5% upside.
In order to determine whether wages, rates and inflation would rise in a cycle of growth that reinforces itself, many BOJ members want to assess the impact of the adjustment made in December over a much longer period of time.
In light of Governor Haruhiko Kuroda’s repeated calls for keeping policy extremely lax, the BOJ may decide to do nothing until his replacement assumes office in April.
Just under a month after the policy shift, bond sellers violated the BOJ’s 0.5% ceiling on Friday, requiring the central bank to engage in emergency buying to drive the yield back down.
As the BOJ’s credibility is put to the test, it can take more action in response.
It may make technical adjustments to the yield curve, such as adjusting its bond purchases or other market activities. Alternatively, it might enlarge the area around its target 10-year yield.
Many decision-makers are hesitant to expand the range by more than 1% since doing so could make it difficult for the BOJ to claim that it is directing the 10-year yield “about 0%.”
There is a possibility that the BOJ would hike its 10-year yield goal or completely let go of YCC.
Before making changes to its yield targets, the BOJ had planned to wait for additional proof that wages would increase sufficiently to keep inflation stably close to its 2% target.
To do so at this time would go against Kuroda’s promise to maintain an ultra-loose monetary policy until the latest cost-driven inflation is supplanted by persistent strong demand-driven price increases.
As opposed to the beginning of a series of rate increases, the BOJ would characterise any such action as a moderate withdrawal of stimulus. It may promise to purchase enough bonds to guard against any sudden, upsetting increase in borrowing costs.
The BOJ may change its advice, which commits to maintaining interest rates at “present or lower” levels, to one that adopts a more impartial stance on the outlook for rates.
Any such action would be a blatant indication that the BOJ expects the economy to stabilise in time for it to begin gradually raising rates.
The BOJ might stop charging the 0.1% fee for a small pool of surplus reserves that financial institutions keep on deposit with the government’s main bank.
The BOJ might begin paying interest on surplus reserves after dropping that negative rate to absorb excess liquidity from the market.
Only when the BOJ believes that Japan’s economy has entered a positive cycle, in which increasing prices lead to increased wages that provide people more spending power, does it intend to take such a step?
Ending negative rates will help commercial banks, whose margins have been smashed by years of super-low rates, feel less pain. However, it would slow the economy by increasing interest rates on bank loans and mortgages.
Therefore, the BOJ won’t want to act hastily. Any such shift would most likely occur concurrently with, or much after, the 10-year yield target’s conclusion.
