BOJ allows more flexibility in yields amid inflation uncertainty

What did the BOJ do?

The Bank of Japan (BOJ) has decided to allow more flexibility in yields beyond the existing tolerance band for the 10-year Japanese Government Bond (JGB) yield target of +/- 0.50 percentage point. This move is aimed at improving the sustainability of the current easing framework, especially considering the “extremely high uncertainties” in the inflation outlook. By not strictly capping yields, the BOJ believes it will enhance bond market functioning and prevent increased market volatility when potential upside risks in inflation materialize.

How did investors react?

Investors are uncertain about whether this adjustment represents a mere technical change or marks the beginning of a more significant tightening cycle. While the BOJ did not officially cite fighting inflation as the reason for the tweak, the bank acknowledged the persistent inflationary pressures by revising up its inflation forecast. Core consumer inflation, excluding fresh food, is now expected to reach 2.5% in the fiscal year ending in March, up from the previous estimate of 1.8%, with potential further upward risks.

What did the BOJ say?

BOJ Governor Kazuo Ueda downplayed the move as a shift from dovish to neutral, asserting that it was done to heighten the chance of sustainably achieving the price target. Analysts believe that this flexibility tweak shows the central bank is not yet ready to tighten monetary policy by raising interest rates.

What are the implications for future policy?

However, the longer inflation stays above the target, the greater the possibility that the BOJ may need to follow up with an actual tightening of monetary policy in the future. The timing is crucial, especially if inflation has truly returned to Japan, as it would require rate hikes just as other major central banks are contemplating interest rate cuts.

The effectiveness of the BOJ’s yield curve control has been questioned by some experts, as it distorts the natural functioning of the markets. The central bank seems to be looking to move away from this policy, and Friday’s move was seen as an opportunistic step to catch investors by surprise. The markets are likely to test the BOJ’s resolve as it gradually shifts away from the yield curve control policy over the next year while maintaining the short-term rate target to support Japan’s monetary policy.