BOJ Eases Rate Control as End of Yield Management Approaches – Reuters

By Leika Kihara and Tetsushi Kajimoto

TOKYO – The Bank of Japan (BOJ) has further loosened its control over long-term interest rates by modifying its bond yield control policy on Tuesday, taking another step towards unwinding its long-standing monetary stimulus measures.

While maintaining its ultra-low interest rates, the BOJ adjusted its previously established 1% cap on yields, allowing long-term borrowing costs to rise more freely. The bank’s board of nine members has also revised its inflation forecasts, projecting that inflation will significantly exceed the 2% target for this year and the next. This change reflects an increasing belief that the conditions necessary for phasing out its ultra-loose monetary policy are falling into place.

However, the yen fell against the dollar following the decision, as traders emphasized the BOJ’s commitment to maintaining its accommodative policy and its forecast that inflation would dip back below 2% by 2025.

"We still haven’t seen enough evidence to feel confident that trend inflation will sustainably hit 2%," BOJ Governor Kazuo Ueda said during the press briefing after the announcement. He added that there is no substantial risk of the BOJ lagging behind market trends.

As anticipated, the BOJ kept its short-term interest target at -0.1% and maintained its target for the 10-year government bond yield around 0%. However, it redefined the 1% threshold for the 10-year yield to be a flexible "upper bound" rather than a strict cap, eliminating the previous commitment to buy an unlimited amount of bonds to defend this level.

Previously, the BOJ had effectively limited the benchmark yield at 0.5% until July, when it increased the cap to 1% to address market distortions from years of extensive bond purchases.

This decision highlights the challenges the BOJ faces as rising global bond yields and persistent inflation complicate its bond yield control strategy.

Despite this, the BOJ maintained its outlook for modest economic recovery, although it cautioned about “extremely high” uncertainty due to risks like declining global demand.

Ueda stated that the BOJ will no longer aggressively defend the long-term rate cap at 1% but will intervene if the yield sharply exceeds this level, indicating a desire for more flexibility in the bond yield control framework.

Through the adjustments, Ueda’s remarks suggested that the central bank is indeed moving away from its strict yield control. After the BOJ’s review, the 10-year Japanese government bond yield increased by 6 basis points, reaching approximately 0.95%, its highest level in a decade.

As other major central banks have raised interest rates significantly over the past year to tackle inflation, the BOJ has maintained a more dovish position. However, this approach has come under pressure from ongoing cost pressures that have kept Japan’s inflation above the 2% target for more than a year.

The BOJ’s earlier firm defense of the yield cap faced criticism, prompting the increase of the de-facto ceiling from 0.5% to 1% in July. Rising global bond yields have further complicated the BOJ’s situation, pushing the 10-year yield toward the new cap.

In light of the expanding inflationary pressure, nearly two-thirds of economists surveyed expected that the BOJ would end its negative interest rate policy next year.

Despite signs of progress toward sustainably achieving the 2% inflation target, Ueda emphasized that the BOJ would not rush to terminate either the yield control or the negative interest rates.

"The main driver behind the recent overshoot is prolonged cost-push inflation," he explained, referencing increases in import prices for commodities like oil.

Ueda will closely observe annual spring wage negotiations as a key factor in policy decisions moving forward. He provided little indication of the order in which the central bank might dismantle its negative rate policy or bond yield control, stating this would depend on economic and price developments.

The BOJ’s current strategy is to retain both yield curve control and negative interest rates until achieving sustained progress toward the 2% inflation goal becomes evident.

Although Ueda has carried forward a dovish stance, ongoing pressures, including a weak yen, have led the BOJ to ease some of the stimulus measures from the previous era. Analysts predict that the process of adjusting these policies will continue, albeit at a cautious pace.

Ultimately, Ueda’s recent decision has been interpreted by some analysts as a significant step away from rigid yield control, raising the potential for a shift in policy normalization sooner rather than later.