Bank of Japan defies market bets for policy tweaks, yen tumbles

TOKYO, Japan – The Bank of Japan (BOJ) on Wednesday, January 18, maintained ultra-low interest rates, including a bond yield cap it was struggling to defend, defying market expectations it would phase out its massive stimulus program amid mounting inflationary pressure.

The surprise decision sent the yen skidding against other currencies and bond yields tumbling the most in decades, as investors unwound bets they made anticipating the central bank would overhaul its yield control policy.

Instead of changing its stimulus program, the BOJ crafted a new weapon to prevent long-term rates from rising too much – a move some analysts took as a sign Governor Haruhiko Kuroda will hold off making big policy shifts during the remaining months of his term, which ends in April.

“This step will allow us to push down longer-term interest rates, without directly affecting supply and demand of the cash Japanese government bond (JGB) market,” Kuroda told a news conference. “We’d like to use this tool for various maturities, and in various ways.”

Following its two-day policy meeting, the BOJ kept intact its yield curve control (YCC) targets, set at -0.1% for short-term interest rates and around 0% for the 10-year yield, by a unanimous vote.

The central bank also made no change to its guidance that allows the 10-year bond yield to move 50 basis points either side of its 0% target.

“Uncertainty regarding Japan’s economy is very high. It’s necessary to support the economy with our stimulus policy, to ensure companies can raise wages,” Kuroda said.

The BOJ’s decision to beef up its key market operation tool is expected to help curb rises in long-term interest rates but importantly underscores its dogged commitment to defend the cap.

“Widening the yield band or dismantling YCC now would have made the BOJ even more vulnerable to market attack,” said Izuru Kato, chief economist at Totan Research.

“By showing its resolve to use market tools more flexibly, the BOJ wanted to signal to markets it won’t make big monetary policy changes under Kuroda.”

Kuroda’s last policy meeting will be held on March 9 to 10, ending a decade helming the bank that brought about radical monetary stimulus but ultimately failed to meet its objective of sustainably reviving anemic consumer demand.

The BOJ’s decision on Wednesday follows its surprise move last month to double the yield band, a tweak analysts say has failed to correct market distortions caused by its heavy bond buying.

The dollar briefly rose 2.4% to 131.20 yen on the BOJ’s announcement, marking its biggest one-day jump since March 2020, while the Nikkei stock average jumped 2.5% to 26,791.12, its highest close since December 19.

JGB yields tumbled across the curve with the benchmark 10-year yield sliding to 0.37%, well below the BOJ’s 0.5% ceiling and posting the biggest one-day decline since November 2003 at one point.

Dimming growth prospects

Since December’s action, the BOJ has faced the biggest test to its YCC policy since its introduction in 2016 as rising inflation and the prospects of higher wages gave traders an excuse to attack the central bank’s yield cap with aggressive bond selling.

While the BOJ has decided to stand pat for now, some lawmakers who once supported aggressive monetary easing now see an end to YCC as inevitable.

Speaking in Davos after the BOJ’s decision, Trade Minister Yasutoshi Nishimura, for one, said Japan was nearing the phase where easy policy could be stopped as wages rise.

Market attention is already shifting toward monetary policy under Kuroda’s successor, who will need to steer an orderly exit from decades of ultra-low rates.

“Whatever message the current BOJ leadership sends out, market expectations of a future tweak to YCC will continue,” said Toru Suehiro, chief economist at Daiwa Securities.

In a quarterly report released on Wednesday, the BOJ raised its core consumer inflation forecast for the current fiscal year ending March to 3%, from 2.9% projected in October.

It also revised up the inflation forecast for the fiscal year ending March 2025 to 1.8% from 1.6% previously.

However, it held its inflation forecast for the fiscal year ending March 2024 at 1.6%, a sign the board is sticking to the view prices will moderate as the effect of past surges in raw material costs dissipates.

The BOJ also slashed its economic growth projections for the next two fiscal years, amid worries slowing global demand will weigh on the export-reliant economy.

Kuroda, however, said the BOJ projected wages to rise at “quite a fast pace,” as corporate profits are at record highs, the job market is tightening, and the economy was seen expanding above potential for three straight years.

Japan’s core consumer inflation has exceeded the BOJ’s 2% target for eight straight months, as companies raised prices to pass on higher raw material costs to households.