Kazuo Ueda of the Bank of Japan (BOJ) finds himself in a precarious situation. As the BOJ considers its stance on monetary policy, Ueda faces the risk of the yen plummeting to historic lows and the vulnerability of his yield control program to speculative market attacks. Simultaneously, if he opts to raise the ceiling on 10-year yields, whether explicitly or implicitly under yield curve control (YCC), it could lead to long-term rates surging to levels inconsistent with economic fundamentals, thereby jeopardizing his goal of achieving stable inflation.
The policy discussions have become highly delicate, with BOJ officials closely monitoring yield movements until the very last moment before deciding whether to adjust YCC, according to insiders familiar with the matter.
“The BOJ is in an extremely tough position,” remarks Tsuyoshi Ueno, senior economist at NLI Research Institute in Tokyo. “Whatever it does, it can’t make everybody happy.”
A Bloomberg survey reveals that most economists believe Ueda is inclined to wait for more evidence of wage growth and a more solid price trend before considering the abandonment of the BOJ’s negative interest rate next spring. Three-quarters of them believe that this can be achieved without altering policy settings during the two-day gathering that concludes on Tuesday.
However, a dissenting group thinks Ueda should make a move to buy more time if he’s not ready to pivot on policy just yet.
The speculation regarding potential changes in the BOJ’s policy is fueled by three main factors: the yen, yields, and prices.
The yen reached a year-to-date low recently, raising concerns about potential government intervention to support it. The BOJ’s continued stimulus to boost inflation is one of the primary factors contributing to the currency’s weakness, a stance conflicting with higher interest rates globally aimed at curbing price growth. As of 12:48 p.m. in Tokyo, the yen remained relatively stable at 149.57 versus the dollar.
Simultaneously, government bond yields are closing in on the BOJ’s 1% ceiling, a level the BOJ deemed unlikely to be reached in July. The yield touched a fresh decade high of 0.89% on Monday, following gains that prompted additional bond purchases by the central bank. Notably, an auction of two-year government notes on Monday had the lowest bid-to-cover ratio since 2010.
Each round of bond-buying by the BOJ serves as a reminder of its ultra-easy policy, perpetuating downward pressure on the yen. These extra bond purchases also raise questions about the effectiveness and sustainability of the bank’s easing program.
In 2016, the BOJ shifted away from quantitative easing and implemented yield curve control to make its stimulus more sustainable. However, this year, the bank is on track to match or even surpass its bond purchases record, as it pulls out all the stops to defend its framework.
“No other central bank has to face these complicated problems,” states NLI’s Ueno. “It shows the challenge of trying to stick with YCC.”
Another significant challenge for Ueda is explaining how close he is to achieving his inflation target. Price growth has exceeded the BOJ’s 2% target for more than a year and a half, prompting a series of government measures to mitigate the cost-of-living pressure it has triggered, with more expected in an economic package later this week.
The acceleration in Tokyo consumer inflation in October has added more pressure on policymakers. Data from Friday, a leading indicator for national trends, revealed that prices, excluding fresh food, rose by 2.7% in the capital.
Market players anticipate the BOJ to raise its price forecasts for this fiscal year and the next. This implies that the BOJ is forecasting Japan’s key inflation to remain above 2% for three consecutive years, a feat the nation has not achieved since the early 1990s. This raises questions about why the BOJ is maintaining stimulus measures.
Despite making progress largely in line with expectations, the consensus among insiders is that the BOJ’s target of stable inflation at 2% is not yet in sight. This suggests that there won’t be any significant moves toward policy normalization at the meeting, such as ending negative rates.
However, market players believe there’s a higher likelihood of change. Ten-year overnight-indexed swaps already exceed the BOJ’s effective yield ceiling, indicating that traders are betting on or at least hedging against a rise in bond yields.
In case changes are made to YCC settings, there are various options, including raising the rate for daily fixed-rate operations from the current 1%, eliminating the 0.5% reference point on yield movements, and adjusting the daily conduct of the policy, according to those familiar with the matter.
Raising the cap on yields could narrow the rate differential with the U.S., thereby relieving pressure on the yen and paving the way for policy normalization by allowing yields to move closer to freely traded levels. However, this could also weaken the impact of the BOJ’s stimulus, potentially signaling fear to market speculators. The collapse of the Reserve Bank of Australia’s yield target in 2021 serves as a cautionary example of the risks associated with giving market players the impression that a central bank is retreating.
