MNI BOJ WATCH: YCC Tweak Unlikely, To Discuss Higher Cap

The Bank of Japan board will likely keep its yield curve control policy and not raise the 10-year interest rate cap when it meets between Oct 30-31 due to uncertainty over 2024 wage hikes and the economy's ability to achieve the bank’s 2% price target, but debate over the appropriateness of the policy will feature heavily in deliberations.

Bank officials are reluctant to adjust the 10-year cap higher as the rally in long-term U.S. yields has driven rising long-term rates, not inflation expectations. A higher cap could also negatively impact the economy by raising medium-term rates, which are more sensitive to economic activity. Traders could also learn to anticipate future adjustments if the BOJ raised the cap amid speculative rate movements, officials believe. Another possible option is that the BOJ maintains the cap at 1.0%, but tolerates a move in a range of +/-0.5 pp.

However, should the 10-year Japanese government bond yield rise to 1% or higher and stock prices trade lower before the meeting, policymakers will consider raising the long-term cap to maintain the YCC framework.

But officials are concerned the bank could distort the market if it actively purchases 10-year bonds during a fixed-rate operation of 1.0% to fight higher yields. The rise of the 10-year JGB yield to 0.885% on Thursday was beyond BOJ expectations and prompted some officials to consider possible policy options ahead of the Oct 30-31 meeting, MNI understands.

U.S. interest rates may stay elevated as higher term premium has partly driven a recent rise, which has kept upward pressure on JGB yields, officials note. The BOJ in theory could raise the 10-year interest rate cap as a precaution, however, this would not constitute a rate hike unless the bank increases the 10-year target from about zero percent, or widens its range from between +/-0.5 pp, which is linked to price assessment. Persistently low real interest rates will enable the BOJ to raise the cap without serious adverse impact on the economy.

Bank officials are also worried about the impact of the weak yen on import prices amid the government’s aim to fight high prices through economic stimulus.

UPWARD REVISIONS

The slower-than-expected y/y drop in core CPI will prompt the BOJ to raise the median inflation view this fiscal year to close to 3% from July’s 2.5%, but focus will rest on how the bank revises its median core-core inflation view in fiscal 2025 from 1.8%.

Japan's annual core CPI rate slowed to 2.8% y/y in September from August's 3.1% but stayed above the Bank of Japan's 2% target for the 18th straight month, data released by the Ministry of Internal Affairs and Communications earlier in the month. (See MNI BRIEF: Japan Sept Core CPI Rises 2.8% Vs. Aug 3.1%) Former policymakers have noted future policy adjustments will rest on whether the bank becomes more confident of achieving its forecast for fiscal 2025 median core-core inflation of 1.8%. The higher-than-expected October Tokyo CPI data will also be added grist for discussions.

The bank could revise the metric to 1.9%, but a 2% revision is unlikely as policymakers do not want to signal the 2% price target is in sight prematurely and increase speculation over its easy policy exit strategy. Policymakers will review the FY2025 price view in April when wage hikes next year become clearer.