MNI POLICY: BOJ Sees Pressure On Zero Percent YCC Anchor

The Bank of Japan is concerned about the durability of the "around zero percent" anchor of its yield curve control policy, as it could complicate moves to further widen the band around the 10-year yield target to help manage distortions in the bond market, MNI understands.

If the BOJ widened the range to 75bp from 50bp to aid bond market functioning, the upward shift in yields would become increasingly inconsistent with the “around zero percent” focus of the 10-year yield target that is integral to the bank's yield curve control (YCC) policy. The central bank shocked global markets by widening the band to 50bp from 25bp on December 20. (See MNI BOJ WATCH: Kuroda Dismisses Shock Shift As Tighter Policy)

Unless the BOJ raised the 10-year target from "around zero percent", policymakers would face difficulties in the widening the range as it would increasingly strain the credibility of the bank's self-imposed target as yields move upwards to reflect higher inflation and similar moves in global bond markets.

The setting of the short-term interest rate at -0.1%, coupled with the targeting of the long-term interest rate at "around zero percent", bookend the BOJ's monetary policy under YCC to achieve its 2% inflation target. The BOJ will not change YCC unless it is confident it can achieve its 2% price target in a stable and sustainable manner.

Even if the BOJ board’s median forecast for inflation in fiscal 2023 and 2024 rises to 2%, it will not immediately prompt a change in policy amid ongoing downside risks to both the Japanese and global economies from slowing growth caused by aggressive rate hikes.

MARKET FUNCTIONING

The BOJ introduced YCC in September 2016 to strengthen monetary easing. Therefore, any raising of policy interest rates would be interpreted as a reversal of easy policy.

Policymakers could widen the range without changing the YCC framework by repeating the logic used to justify widening of the band in December, with the move viewed as vital to restore the functioning of the Japanese government bond and corporate bond issuance markets. The policy tweak aimed to encourage smoother formation of the yield curve, which had developed a kink at the 10-year maturity. (See Kink In The Curve Still Evident Post-BOJ YCC Tweak)

Bank officials are monitoring how financial markets will evolve and stabilise following December’s decisions, although they acknowledge it will take some time to ascertain the effects of the policy change. They are worried about the risk that the 10-year yield hovers at 0.50%, the upper limit of the range, strengthening distortions in the market and increasing pressure on the BOJ to consider widening the band again.

The evolving dynamics in the JGB market will increase pressure on the BOJ under the new governor, who takes office on April 9 and is expected to to conduct a review of the policy framework, including the effects of YCC. (see MNI POLICY: Kuroda's Legacy Looms As Leadership Race Narrows)