MNI POLICY: BOJ Mulls Softer 10-Yr Target, Flexible YCC Bands

The Bank of Japan may soften its stance on its 'around 0%' long-term interest rate target and remove the current trading band, but it will likely pledge to keep the yield curve at low levels through all possible measures, MNI understands.

The Bank could aim to promote an environment where interest-rates move based on the market view’s of the economy under a more flexible YCC, possibly amending its stance as soon as the next policy meeting, MNI understands. But the BOJ will keep buying Japanese government bonds and maintain its fixed-rate bond buying operation, not only to restrict surges in interest rates, but also to stabilise financial markets.

In July 2018, the BOJ revealed it would allow the 10-year yield to move in a narrow band around 0% (seen as a 0.1% symmetrical move) and in March 2021 widened the band to 0.25% either way, further widening it to 0.5% in late 2022. The Bank’s goal was to stimulate bond trading which had suffered due to the impact of YCC.

The BOJ could also repeat its past quantitative analysis of the effects of its JGB purchases, which have statistically significant effects on long-term interest rates, lowering them by about 1 pp on average.

Despite the potential tweak, the BOJ will likely note the underlying price trend has not sufficiently strengthened and the risk to prices skew down to continue its easy policy. Bank officials will focus on the risk that the market could interpret any YCC adjustment to mean the Bank will move toward near-term normalisation.

Bank officials, however, want to avoid the mistake of the U.S. Federal Reserve, which raised interest rates sharply following unexpected, escalated inflation. The BOJ has said it will patiently continue with monetary easing, “while nimbly responding to developments in economic activity and prices as well as financial conditions.”

VARIOUS POSSIBILITIES

The BOJ could adjust YCC in various ways, but it wants to find the optimal path and undertake it in the most efficient way. Widening the 10-year interest rate range from the current 50bp could represent one such option, but a wider band will not align with the BOJ’s “around 0%” target.

The widening could also increase the BOJ operation department’s tolerance for wider rate moves and lead the board to concentrate on policy decisions, leaving management to operations.

A rise in inflation expectations to about 1% from zero for a prolonged period could theoretically enable the BOJ to raise the long-term interest rate target, but the market could regard this as a step toward near-term policy normalisation, which will push interest rates higher more broadly. The market may also regard the removal, or shortening, of the long-term target in a similar way. In addition, should the BOJ adjust the target, market players will speculate on future moves, again pushing rates higher.