In a significant policy shift, the Bank of Japan (BOJ) announced on Friday that it would relax its yield curve control, leading to tumultuous reactions in financial markets and raising concerns about the impact of its prolonged monetary easing on the economy. The central bank’s decision came as a response to the need for greater flexibility due to the “extremely high uncertainties for Japan’s economic activity and prices.”
A Fresh Approach from BOJ
The BOJ’s new approach involves allowing 10-year Japanese government bond (JGB) yields to fluctuate within a range of approximately plus and minus 0.5 percentage points from its existing 0% target level. Moreover, the bank also introduced fixed-rate operations to purchase 10-year JGBs at 1%, effectively expanding its tolerance level by an additional 50 basis points.
This policy adjustment marks the first major change implemented by Bank of Japan (BOJ) Governor Kazuo Ueda since assuming office in April. Alongside loosening the yield curve control, the central bank decided to maintain its ultra-loose interest rate, keeping the short-term interest rate target at -0.1% following the July policy meeting. Additionally, the BOJ revised its median forecast for inflation in fiscal 2023, raising it to 2.5%, up from the previous prediction of 1.8% made in April.
Comparing the Flexibility of Language
Analysts compared the new “flexibility” language used in the BOJ’s policy statement to that employed in late 2022 when the 10-year JGB target range was expanded from +/-25 basis points to +/-50 basis points. Commonwealth Bank of Australia’s chief economist, Stephen Halmarick, noted that this adjustment signifies a degree of tightening in monetary policy.
The move by the Bank of Japan comes after years of accommodative monetary policies, diverging from the tightening measures taken by many other global central banks over the past year. Such policies have resulted in carry trades being heavily concentrated in the Japanese yen. Carry trades involve borrowing at lower interest rates to invest in other assets that offer higher returns.
Impact of the Announcement
The announcement of the Bank of Japan’s policy change led to an immediate sell-off, causing yields for the 10-year JGB to reach their highest levels since September 2014. Concurrently, the Japanese yen strengthened against the dollar, further impacting financial markets. Following the news, both the Nikkei and Topix benchmark stock indexes experienced deepened losses, while shares of Japanese banks surged in Tokyo, with Mitsubishi UFJ witnessing a remarkable jump of more than 4%.