(Bloomberg) — The Bank of Japan jolted financial markets by loosening its grip on bond yields in Governor Kazuo Ueda’s first surprise move since taking the helm, a step that will likely spur talk of potential policy normalization to come.
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Japan’s benchmark bond yield surged, extending gains above the central bank’s previous 0.5% cap. The yen whipsawed, falling more than 1% before reversing course and rallying to trade about the same amount higher — and then giving up those gains.
The BOJ kept its target for 10-year yields at around 0% but said its 0.5% ceiling was now a reference point, not a rigid limit as it sought to make its easing program more flexible. The bank also said it will offer to buy 10-year government debt at 1% each day, while leaving its short-term negative interest rate unchanged at -0.1%.
“This isn’t a step toward normalization,” said Ueda, following the decision. “We’re still far from where we can raise short-term rates.”
The yen had surged going into the meeting following a Nikkei report that said the BOJ’s board would discuss whether to tweak yield curve control policy to let long-term interest rates rise above its cap.
Speculation of YCC changes has continued to simmer since last year, amid a global wave of policy tightening to rein in inflation that is nearing its end after the Federal Reserve and European Central Bank hiked rates again this week.
Ueda and his board will likely continue to argue that with inflation still lacking a sure footing, keeping the main policy settings unchanged shows that the new guidance on the band was a technical move aimed at improving the sustainability of stimulus, rather than a step toward imminent policy normalization.
“Simply widening the 0.5% range would’ve been seen as an effective rate hike, so the BOJ avoided giving that impression by setting 1.0% for fixed-rate purchases,” said Nobuyasu Atago, chief economist at Ichiyoshi Securities and a former BOJ official. “That makes it harder for the markets to judge the moves as a clear tightening step.”
The latest forecasts released with the decision show that while the BOJ now sees inflation averaging well over 2% this year, it predicts it will weaken below the target in the next fiscal year, a projection that suggests the bank may need to keep its stimulus going for longer. During his press conference Friday, Ueda repeatedly said that distance remains to achieving the BOJ’s stable 2% price goal.
But some market players remain unconvinced. A pledge by the central bank to buy 10-year government debt at 1% each day instead of 0.5% would suggest a new line in the sand at 1%, a level that would mean an effective doubling of the movement range. Japan’s bond benchmark hit as high as 0.575% in early afternoon trading in Tokyo.
That means Ueda will continue to face a tough communications challenge over the coming months to argue that the move isn’t simply another step toward the end of yield curve control.
“The BOJ is starting its withdrawal from yield curve control,” said Hirofumi Suzuki, chief FX strategist at Sumitomo Mitsui Banking Corp., who had forecast YCC adjustment at this meeting. “It’s a bold move to basically raise the upper band to 1%. The BOJ probably thought it’s easier to do it in one go rather than in stages.”
Only 18% of 50 economists polled by Bloomberg were expecting a YCC tweak at this meeting, though about half foresaw such a move no later than October. Economists largely agreed that any change to the program would have to come as a surprise, as any foreshadowing might trigger a surge in bond selling, complicating the move.
What Bloomberg Economics Says…
“The move tarnishes Governor Kazuo Ueda’s reputation as a clear communicator. Ueda has been consistent in sending dovish signals. But his actions may now be perceived as unpredictable and even hawkish.”
— Taro Kimura, economist
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In the end, Ueda probably chose to rid the board of a major headache at an early stage in his tenure, taking advantage of relative calm in the market, as investors mostly stopped trying to test the BOJ’s resolve to defend its targeted ranges in recent months.
“We were more aware of future risks this time,” said Ueda, stressing that it would be harder to make changes to YCC after upside price risks emerge. Given the relative calm in the markets, “we thought that it was the perfect time to make adjustments,” he said.
The bank last surprised investors in December, when it doubled its yield cap in a move that now appears to have been insufficient to allay concerns at the bank over the side effects of the program.
A growing consensus that the US and European central banks are nearing an end to their tightening cycles has eased upward pressure on global bond yields, a development that offered a window of opportunity for the BOJ to adjust YCC with a lower risk of a surge in Japanese yields.
Japan’s stocks hit a 33-year high earlier this month and the yen has stayed around 140 per dollar, limiting the adverse impact from yield control adjustment.
“While the market may still be trying to parse through the BOJ messages, we take the BOJ’s adjustment as an early step towards an eventual exit from the YCC policy down the road,” said Alan Lau, FX strategist at Maybank. “In effect, they are now raising the cap to 1.00%. Currency wise, this should favor yen appreciation.”
–With assistance from Yoshiaki Nohara, Nurin Sofia and Brian Fowler.
(Updates with comments from press conference. A previous version amended the spelling of European Central Bank.)
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