By Wei Hongxu
On July 28, the Bank of Japan (BOJ) announced its latest interest rate decision, keeping the key short-term rate unchanged at -0.1%. However, on the other hand, the central bank introduced new wording regarding a 0.5% upper limit on 10-year Japanese government bond yields. It stated that it will consider this upper limit and the corresponding -0.5% yield as “references, not as rigid limits”. The BOJ also declared its intention to purchase Japanese government bonds with a 1% yield on a daily basis.
By maintaining the unchanged interest rate while implicitly expanding yield curve control (YCC), the BOJ’s approach aligns with the expectations of some market institutions that had anticipated an adjustment to the policy. According to researchers at ANBOUND, this recent change effectively extends the practice of last year’s adjustment to the YCC range, indicating that Japan’s monetary policy is essentially entering a process of gradual transition.
When the BOJ began adjusting the yield curve range last year, researchers at ANBOUND pointed out that this change in Japan’s monetary policy would be the world’s most significant uncertain policy factor in 2023. In the long run, factors such as Japan’s continuously rising inflation, the near-limit of the long-standing asset purchase policy, and the yen’s depreciation due to widening interest rate differentials in the U.S. and Europe, all imply that the BOJ’s ultra-loose monetary policy is heading towards an end. However, it is also concerning that the bank’s move towards exiting quantitative easing due to achieving its inflation target could lead to unpredictable transition risks. BOJ Governor Haruhiko Kuroda has previously stated that Japan needs to exit ultra-loose policy at some point, and once the negative interest rates and YCC end, it may create spillover effects on its assets. Against this backdrop, many market investors are now engaging in speculation, hoping to gain excess returns when the Japanese central bank ends its YCC policy. As risks accumulate, any sign of a policy shift by the BOJ could bring market turbulence.
According to researchers at ANBOUND, the challenges faced by the BOJ have only just begun. The rise in the Japanese stock market does not necessarily indicate limited policy risks. It actually reflects, on one hand, that international capital is still flowing back into the Japanese stock market, driving up stock prices. On the other hand, this is also what the BOJ hopes to see as it adopts a gradual transition policy.
However, this situation is not good news for the global bond market. The increase in interest rates means a decrease in bond market prices, which may lead to market sell-offs of Japanese bonds, especially Japanese government bonds, which are considered safe-haven assets. In this situation, the Japanese central bank will face a more awkward dilemma. Either it intervenes to maintain the yield curve, or it lets the market interest rates spiral out of control, rendering the negative interest rate policy ineffective.
Analysts from Gelonghui suggest that in extreme cases if Japanese government bonds face credit risk, it will not only impact Japan domestically but also affect the global financial system. For years, the Japanese yen has been the best safe-haven asset. If the global financial system loses such a safe haven, overall risks will increase, and funds will be redistributed. This kind of turbulence is unavoidable for any investor. This is a situation that the BOJ needs to be vigilant about and avoid during its transition process.
According to researchers at ANBOUND, the BOJ is currently maintaining a policy of continuous asset purchases, expanding the YCC range, and keeping the negative interest rate unchanged. This appears to be a continuation of its super-loose monetary policy, but in essence, it has already started to change. As market interest rates gradually rise, the extent of its looseness will narrow continuously until it eventually changes the negative interest rate policy.
Market expectations are that the BOJ will only abandon the negative interest rate policy at the earliest by next year when inflation reaches the 2% target line. During this process, the Japanese central bank will not stop its super-quantitative easing to avoid causing significant market shocks with an abrupt policy shift. This policy change reflects the BOJ’s cautious approach to monetary policy adjustments and indicates the severity of the current economic and financial environment in Japan, leaving no room for any missteps for it.
Final analysis conclusion:
Currently, the Bank of Japan’s adjustment of the yield curve control policy signifies that its policy adjustment has begun. Continuing with quantitative easing during this process indicates that the adjustment will be relatively prolonged to achieve the policy objective of balancing economic growth and inflation. However, throughout this process, it also implies an increase in policy risks for global markets. This risk not only affects Japan domestically but also has fundamental implications for the wider world.
Wei Hongxu is a researcher at ANBOUND