The Bank of Japan is once again considering a scenario in which demand strengthens and it is able to raise its overnight lending rate from negative levels while still maintaining yield curve control in order to limit the market reaction, though this is still a low probability outcome, MNI understands.

In recent months, the BOJ has anticipated that it will first gradually loosen and then exit from yield curve control, perhaps by next April, as wage growth firms and inflation stabilises sustainably above 2%.

This remains the most likely scenario. But a rapid improvement in demand, exerting upward pressure on price expectations, could potentially prompt it to first raise short-term rates to 0% from the current -0.1%. This was an option it also looked at under former Governor Haruhiko Kuroda last year, at a time when other major central banks were tightening aggressively. (See MNI INSIGHT: Exit From Negative Rates An Option For BOJ)

Such a move could have a knock-on effect on long-term rates, so maintaining yield curve control could allow the BOJ to limit any corresponding rise in the 10-year yield, officials believe. Even if the BOJ has dropped yield curve control by the time it increases the short-term rate, it will retain its commitment to conduct government-bond purchases in a flexible manner to curb undesirable rises in yields.

UEDA COMMENTS

MNI reported last week that the BOJ could scrap yield curve control if wages data, particularly at smaller firms, remains strong. (See MNI POLICY: April YCC Removal Window Possible On Wage Data) Over the weekend Governor Kazuo Ueda commented that short-term rates could rise from negative levels if the 2% price target achievement is in sight, prompting a surge in 10-year yields and a yen rally. (See MNI BRIEF: BOJ To Offer 5-Year Fund-Providing Operation Thur)

Ueda has previously stressed that trend underlying inflation remains below the bank’s 2% target and has emphasised the need to continue with easy policy and yield curve control until this changes. But the governor and his colleagues have noted a shift in corporate wage- and price-setting behaviour, with more than half of nine board members seeing upside risks to prices this fiscal year and in fiscal 2024.

The Bank’s focus will now shift to whether services prices accelerate accompanied by wage hikes as the impact of cost push on goods wanes.