Bank of Japan defies market pressure and holds firm on yield curve control

The Bank of Japan has defied market pressure and left its yield curve control measures unchanged, sending the yen diving and pushing stocks higher as it stuck to a core pillar of its ultra-loose monetary policy.

Traders in Tokyo said the BoJ’s decision, which came after a two-day meeting, the penultimate under its longest-serving governor, Haruhiko Kuroda, was likely to heap more pressure on his successor to end Japan’s two-decade experiment in massive monetary easing. On Wednesday, Kuroda insisted his programme had been successful, saying the yield controls were sustainable.

The decision followed weeks of turmoil in the Japanese government bond market during which yields surged. The central bank deployed the equivalent of about 6 per cent of Japan’s gross domestic product over the past month on buying bonds to try to hold yields within its target range.

The yield on 10-year Japanese government bonds fell as much as 0.15 percentage points following the announcement, before pulling back to a 0.09 percentage point drop to 0.405 per cent. Japan’s Topix share index rose 1.7 per cent.

Although currency markets have avoided the turbulence that has gripped trading in JGBs, the yen fell more than 2 per cent against the dollar after the BoJ’s announcement.

Benjamin Shatil, a currency strategist at JPMorgan in Tokyo, said it was difficult to interpret the yen’s drop on Wednesday as an inflection, with markets assuming that the BoJ would eventually have to relent to pressure.

“In some ways the decision to make no changes today — neither to policy nor to forward guidance — sets the BoJ up for a protracted battle with the market,” said Shatil.

The BoJ’s unexpected decision in December to allow a higher target yield ceiling on 10-year government debt — permitting yields to fluctuate by 0.5 percentage points above or below its target of zero — had raised the possibility of a historic pivot by the last of the world’s leading central banks still sticking to an ultra-loose monetary regime.

Scrapping the cap on yields would in effect push up interest rates, at least for longer term government debt.

Instead the central bank made no further changes to its yield curve control (YCC) policy on Wednesday, sticking to the range set last month. It kept overnight interest rates at minus 0.1 per cent.

The BoJ said it would also extend the duration of its funds-supplying operations to financial institutions, a move aimed at stabilising the JGB yield curve.

Kuroda, who will step down in April after a record 10 years as BoJ governor, said last month that changes to the YCC limits were meant to improve bond market functioning and were not an “exit strategy”.

On Wednesday, Kuroda stressed that it would take more time for the recent YCC revision to play out. “We do believe market functioning will improve in the future,” he said. “The YCC is sufficiently sustainable.”

Since its last policy meeting on December 20, the BoJ has spent about ¥34tn ($265bn) on bond purchases, with the yields on 10-year bonds continuing to rise above 0.5 per cent. That prompted markets to put pressure on the central bank to abandon the yield target altogether.

“The Kuroda bazooka is over and now it’s really up to the new governor to change things and start from scratch,” said Mari Iwashita, chief market economist at Daiwa Securities. Before the policy meeting, Iwashita had said the YCC framework was in “a terminal condition”.

Citigroup, which had expected the BoJ to scrap YCC this week, said that decision would now probably be made during the new governor’s first meeting in April. Fumio Kishida, Japan’s prime minister, is set to name Kuroda’s successor within weeks.

“The problems with YCC are pretty explicit, so there isn’t much of a need to debate about its side-effects under the new governor,” said Citigroup economist Kiichi Murashima.

The central bank on Wednesday also raised its inflation outlook for the fiscal year ending in March, projecting Japan’s core inflation, which does not include volatile fresh food prices, to be 3 per cent instead of a previously forecast 2.9 per cent. It now also expects 1.8 per cent inflation in the 2024 fiscal year, instead of 1.6 per cent.

Japan’s consumer price index rose 3.7 per cent in November, its fastest pace in nearly 41 years and above the BoJ’s 2 per cent target for the eighth consecutive month.

Although inflation is still mild in Japan compared with the US and Europe, price rises have gained pace, prompting investors to challenge Kuroda’s assertion that the central bank did not plan to raise interest rates.

The BoJ also lowered Japan’s economic growth forecast for the next two fiscal years, citing a slowdown in other economies.