Weak Yen and Inflation Surge Could Prompt BOJ to End Stimulus by Year-End: Former Official Providing Insights

By Leika Kihara and Yoshifumi Takemoto

TOKYO – The Bank of Japan may prefer a gradual approach to ending its ultra-low interest rates, but the weak yen and the potential for inflation to exceed expectations could push the central bank to take action before the end of the year, according to former central bank official Hiromi Yamaoka.

Facing pressure to phase out years of substantial monetary stimulus amid rising inflation, the BOJ recently eased its control over long-term interest rates by making adjustments to its controversial bond yield control policy.

Following this decision, the yen fell sharply as the move, along with dovish remarks from Governor Kazuo Ueda, contradicted market expectations for more decisive steps toward policy normalization.

Yamaoka pointed out that the BOJ’s yield curve control (YCC) policy, which maintains the yield around 0%, presents significant challenges for exit. Ending this program could lead to a sudden increase in yields, resulting in substantial losses for bondholders.

"The BOJ must proceed cautiously to achieve a smooth transition. Therefore, it likely wants to move very slowly toward any exit strategy," Yamaoka explained. He has experience in overseeing the BOJ’s market operations and maintains close connections with current policymakers.

Yamaoka worked under Ueda when he was a board member from 1998 to 2005, a time before the aggressive easing measures initiated in 2013 under former governor Haruhiko Kuroda.

The BOJ’s dovish language and focus on upcoming wage negotiations may suggest to markets that an exit from the current ultra-easy policy may not occur until around spring 2024. However, Yamaoka cautioned that the BOJ may not have the luxury of waiting that long, as inflation dynamics could shift rapidly.

The ongoing decline of the yen may also intensify pressure on the BOJ to abandon ultra-low rates sooner than planned. "The BOJ doesn’t have much time left, which is probably something Governor Ueda is aware of," Yamaoka remarked. "I wouldn’t dismiss the possibility of the BOJ taking action before the year ends."

To stimulate inflation towards its 2% target, the BOJ has maintained a cap on the 10-year bond yield around zero since 2016 under YCC. Additionally, the bank imposes a 0.1% charge on excess reserves held at the central bank as part of its negative interest rate policy.

With inflation exceeding the 2% target for more than a year, many market participants are speculating about the potential end of YCC and negative rates in the upcoming year.

Ueda, however, has downplayed the likelihood of a near-term exit, arguing that the BOJ should await more robust evidence that inflation will sustainably reach 2% through solid demand. His cautious perspective highlights concerns that a premature termination of accommodative policies might jeopardize the bank’s long-term efforts to revive Japan from economic stagnation.

Yamaoka emphasized that the BOJ must phase out negative rates in the near future, as the costs of the policy, such as sharp declines in the yen, outweigh its benefits.

While it is likely that the BOJ will continue to relax its control over long-term rates, a complete removal of YCC is improbable, as doing so would create significant disruption in a society accustomed to years of near-zero borrowing costs.

The fate of negative rates and YCC is likely to be discussed as a cohesive package, as the two policies are integral to the BOJ’s broader stimulus strategy. "A successful exit from these policies is a narrow path," Yamaoka stated. "But it is something that the BOJ needs to address as soon as possible."