The Japanese yen strengthened, and the 10-year Japanese government bond (JGB) yield rose after the Bank of Japan announced a “greater flexibility” approach to its target range for 10-year JGB yields. BOJ will buy 10-year JGBs at a fixed rate of 1.0% each business day, unless no bids are submitted.
Yen and bond yields rise after BOJ pledges more flexibility to yield curve control
The Bank of Japan (BOJ) has made changes to its yield curve control policy, a fundamental part of its ultra-loose monetary policy, resulting in a surge in the country's 10-year bond yields to the highest level in nine years. The BoJ stated that it will continue to cap the yield on 10-year Japanese government bonds at 0.5%. However, the BOJ announced a "greater flexibility" approach to its target range, allowing interest rates to rise above this level without setting "rigid limits." Additionally, the BOJ announced that it would purchase 10-year bonds at a fixed rate of 1.0% in fixed-rate operations, which is higher than the previous 0.5%, effectively widening the trading band for long-term yields. During a press conference, BOJ's Governor Kazuo Ueda further indicated that the central bank will ensure that 10-year bond yields do not exceed 1%.
This move has caused some confusion about whether the central bank intends to further normalize its policy. However, the BoJ has kept its overnight rate at -0.1%, stating that more time is required to achieve its 2% inflation target sustainably.
Two Main Reasons for BOJ's Monetary Policy Adjustment
1. BOJ Raises Core Inflation Expectations:
During the July meeting, the BOJ significantly increased its inflation expectations for the current fiscal year, with core inflation projected at 2.5% (previously 1.8%) and core-core inflation at 3.2% (previously 2.5%). This suggests that inflation is gradually approaching the BOJ's target. According to BOJ statistics, 84.9% of CPI components recorded an increase in May, reaching the highest level since data collection began in 2001, indicating a broad-based rise in inflation.
2. Wage Growth Exceeds Expectations:
Japan's labor force saw a 1.7% year-on-year increase in regular wages, marking the largest growth in 28 years. On July 5, the Japan Trade Union Confederation announced the final results of the 2023 Spring Wage Negotiations, revealing that Japanese companies' average wage increase this year is 3.58%, the highest in 30 years.
What’s Next: Potential Further YCC Policy Adjustment, Unlikely to End Negative Interest Rates
BOJ Holds Over 80% of 10-year Government Bonds:
Since introducing the Yield Curve Control (YCC) policy in September 2016, the Bank of Japan has increased its holdings of government bonds by approximately 230 trillion yen. BOJ now owns over 80 percent of outstanding 10-year government bonds. This has led to market distortions, and BOJ has acknowledged the side effects during monetary policy meetings. Therefore, based on our analysis, the BOJ adopted a flexible YCC range during the July meeting, which bought the central bank more time. However, it is likely that the BOJ will need to shift the YCC target to short-term bonds in the future.
Unlikely to End Negative Interest Rates
According to a March report by the Ministry of Finance, Japan's government debt has reached 1,026 trillion yen (equivalent to 212.6% of GDP), the highest in the world. However, due to negative interest rates and yield curve control, the average interest rate on government bonds is currently only 0.8%.
