The Bank of Japan shocked markets on Tuesday with a surprise adjustment to controls on bond yields that allows long-term interest rates to rise further, a move aimed at mitigating some of the costs of prolonged monetary stimulus.
Stocks fell, while yen and bond yields rose following the decision, which put off outside investors who had speculated that the Bank of Japan would not make any changes to its yield curve control (YCC) until Governor Haruhiko Kuroda steps down in April.
In a move described as aimed at revitalizing the dormant bond market, the Bank of Japan decided to allow the 10-year yield to move 50 basis points either side of the 0% target, wider than the 25 basis point range previously.
But the central bank kept its yield target unchanged and said it would sharply increase bond buying, signaling that the move was an adjustment to the current ultra-loose monetary policy rather than a withdrawal of stimulus.
“Maybe this is a small step to test the strategy and see how the market reacts, how reactive it is,” said Bart Wakabayashi, branch manager on State Street in Tokyo. “I think we see the first toe in the water.”
As widely expected, the Bank of Japan kept its YCC targets unchanged, which are set at -0.1% for short-term interest rates and around zero for the 10-year bond yield, at its two-day policy meeting that ended on Tuesday.
The Bank of Japan also said it would increase its monthly purchases of Japanese government bonds (JGBs) to 9 trillion yen ($67.5 billion) per month from 7.3 trillion yen previously.
“Through these steps, the Bank of Japan will aim to achieve its rate target by strengthening the sustainability of monetary easing under this framework,” the Bank of Japan said in a statement, indicating that the move is aimed at prolonging the YCC rather than phasing it out.
The Nikkei 225 index fell 2.5 percent after the decision, while the dollar fell 2.7 percent to a four-month low of 133.11 yen. The yield on 10-year Japanese government bonds (JGB) rose briefly to 0.460%, near the BoJ’s new implied maximum.
Already, markets are guessing what the BoJ’s next move might be as the Kuroda term draws to a close and with inflation expected to remain above its 2% target next year.
“They widened the band, and I think that came earlier than expected. It raises questions about whether this is a prelude to more to come, in terms of policy normalization,” said Moh Seung Sim, currency analyst at Bank of Singapore.
“The writing is on the wall that perhaps the sharp weakness in the yen that we saw earlier was uncomfortable for policymakers…it obviously adds to the story of yen strength next year.”
The Bank of Japan’s ultra-low interest rate policy and its relentless buying of bonds to defend its yield ceiling has drawn mounting public criticism for distorting the yield curve, draining market liquidity, and causing an unwelcome drop in the yen that has inflated the cost of raw material imports.
Kuroda has said repeatedly that he sees no need for the Bank of Japan to adjust the YCC, including taking immediate steps to address side effects such as the distortion it has caused in the bond market.
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