Bank of Japan modifies YCC policy

The Bank of Japan (BoJ) has recently made slight modifications to its Yield Curve Control (YCC) policy, signalling a shift in its strategy for managing interest rates and inflation.

Previously, the BoJ maintained a strict 0% target for the 10-year Japanese government bond (JGB) yield. They were unwavering in their commitment to defending a hard limit of 1% for the yield.

In July, the BoJ decided to widen the tolerance band around the 0% yield target for the 10-year JGB. This move expanded the range from 50 basis points (bps) to 100 bps. This change transformed the 1% yield limit into more of a reference point than a stringent target, allowing for greater flexibility and the possibility for the yield to exceed 1%.

The BoJ indicated its intent to persist in bond purchases, both below and above the target level, signifying their willingness to intervene in the bond market to steer yields in line with their policy objectives.

The decision to adjust the YCC policy was underpinned by revised (core) Consumer Price Index (CPI) forecasts. The BoJ raised its inflation projections for fiscal years 2023, 2024, and 2025. These forecasts suggest heightened expectations for inflation, with multiple years surpassing the central bank’s 2% target.

BoJ Governor Ueda attributed the upward revisions in the CPI forecasts to cost-push inflation and higher oil prices.

The prolonged period of inflation exceeding the 2% target for several years opens the door for the BoJ to contemplate further adjustments to its monetary policy. This could include the possibility of scrapping Yield Curve Control and/or eliminating negative policy rates.

The market had anticipated more substantial changes from the BoJ, and this news resulted in an increase in the USD/JPY exchange rate. It crossed the 150-mark, indicating a weakening of the Japanese yen. Mention of past FX interventions by the BoJ suggests their readiness to influence exchange rates to achieve their objectives.

To summarise, the Bank of Japan’s adjustment to its Yield Curve Control policy reflects a more adaptable approach to monetary policy and a greater tolerance for elevated inflation. The market’s response, particularly the rise in USD/JPY, suggests that market participants were expecting more significant alterations from the central bank.