Japan’s central bank stunned markets with a change in yield control policy

Japan’s central bank stunned markets on Tuesday with a surprise shift in its controversial yield curve control policy, sending currency, bond and stock markets tumbling.

Traders described the move as potentially marking a long-awaited “pivot” by the BoJ, which is the last of the world’s major central banks to stick to super loose mode to avoid raising interest rates to deal with global inflation.

“We view this decision as a big surprise as we had expected any policy expansion under the new BoJ leadership from spring next year, similar to the market,” said Naohiko Baba, chief Japan economist at Goldman Sachs.

However, at a news conference, BoJ Governor Haruhiko Kuroda denied that the latest adjustment was tantamount to a tightening of monetary policy, stressing that the central bank would not lift its yield target.

Japan’s increasingly extreme state of emergency contributed to a a huge drop in the yen this year as markets have priced in the spread with the rate-tightening US Federal Reserve.

The central bank said it would allow the 10-year bond yield to vary by plus or minus 0.5 percent, instead of the previous 0.25 percent. He kept overnight rates at minus 0.1 percent.

Kuroda said earlier that any adjustment to the yield curve control (YCC) would effectively lead to an increase in the interest rate. But on Tuesday he said the adjustment was aimed at addressing increased volatility in global financial markets and improving the functioning of the bond market to “enhance the sustainability of monetary easing”.

“This measure is not a rate hike,” Kuroda said. “Fixing YCC does not mean the end of YCC or an exit strategy.”

Japan’s core inflation – which excludes volatile food prices – exceeded the BoJ’s 2 percent target for the seventh straight month, hitting a 40-year high of 3.6 percent in October.

But Kuroda has long argued that any tightening would be premature without steady wage growth, which is why most economists expected the BOJ to hold rate until it withdraws in April. On Tuesday, the BoJ maintained its outlook that inflation will slow next year and warned of “extremely high uncertainty” about the economy.

“Maybe it’s an act of generosity on Kuroda’s part to ease the burden on the next BoJ governor, but it’s a dangerous move and market players feel cheated,” said Masamichi Adachi, chief Japan economist at UBS. “US yields are falling now, but if they start to rise again, the BoJ will again face the risk of being forced to raise rates.”

The BoJ’s efforts to defend its YCC targets contributed to a sustained reduction in market liquidity and what some analysts described as “dysfunction” in Japanese government bonds market. The central bank now owns more than half of bonds outstanding, compared with 11.5 percent when Kuroda became governor in March 2013.

Kyohei Morita, chief economist for Japan at Nomura Securities, said the BoJ’s move was probably best seen as a policy shift rather than a complete reversal. “The BoJ probably wants to help reduce the negative side effects of the yield curve control policy,” he said, noting that the bank’s huge ownership of the Japanese government bond market meant liquidity had evaporated.

“They want to reactivate this market, even at the cost of the yen appreciating,” Morita said.

The yen briefly jumped nearly 3 percent to around 133 yen against the U.S. dollar, while the Topix stock index fell as much as 2.5 percent and the 10-year bond yield rose to 0.46 percent, its highest since 2015 In recent weeks, the Japanese currency has recovered from a 32-year low as policymakers in the US and Europe began to scale back their rate hikes.

Mansoor Mohi-uddin, chief economist at Bank of Singapore, said the BoJ’s move was significant because it signaled the central bank was considering a broader exit from the YCC, adding that it would be an important turning point for the yen.

“The BoJ’s decision to raise interest rates in December 1989 caused a major shift in Japanese markets,” Mohi-uddin said. “Today’s employees will be very aware of this history. This reinforces the importance of their signal to the markets today.”

Benjamin Chattil, currency strategist at JPMorgan, said the BoJ’s move now would cause the market to start pricing in further policy moves, even if none are actually forthcoming.

“These dynamics could start a new cycle of higher yields in Japan, a test of the new or higher YCC target ceiling and renewed bouts of yen strength,” Shatill said. “This also has implications for global markets, given the potential for continued asset reallocation of Japanese investors from overseas bonds back to domestic bonds – now that they offer more attractive higher yields.”

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