Bank of Japan's Bond Yield Twist: What's New?


The Bank of Japan is gradually relaxing its grip on long-term interest rates by altering its bond yield control policy, signaling a step toward the completion of an extended period of monetary stimulus.

The Bank of Japan's Board has updated its inflation projections, forecasting that it will significantly exceed 2% for the current and next year. This reflects a growing confidence in the potential to shift away from the ultra-loose monetary policy gradually.

That being said, the Bank of Japan's decision prompted a decline in the yen against the dollar, as traders focused on the bank's commitment to persist with the ultra-soft policy and its prediction that inflation won't reach 2% until 2025.

The Bank of Japan's move may have surprised the markets, which had anticipated more substantial changes. As expected, the bank maintained a -0.1% rate target for short-term interest rates and a yield curve control (YCC) yield target of around 0% for 10-year government bonds.

In a significant shift, the Bank of Japan now regards the 1.0% level as an upper limit for yields, rather than a rigid cap, and is no longer committed to buying unlimited quantities of bonds to maintain that level.

Given the high uncertainty in the economy and financial markets, the Bank of Japan stresses the importance of preserving flexibility in managing the yield curve, particularly with persistent inflation complicating this process.

Critics claim that the Bank of Japan's vigorous defense of restrictions distorts the market, leading to an undesirable yen depreciation. In response to these concerns, the bank increased its yield cap from 0.5% to 1.0% in July.

The rising global bond yields present a challenge for the Bank of Japan, with the 10-year Japanese government bond yield reaching a new ten-year high of 0.955% shortly after this decision had been adopted.

While this adjustment may lessen the need for additional bond purchases, it could also bolster market expectations that yield controls and negative interest rates will end in the near future.

Inflation has remained above the Bank of Japan's 2% target for 18 consecutive months while rising inflation expectations are reducing real lending rates.

Despite Governor Ueda's commitment to maintaining ultra-low interest rates, the markets are already beginning to anticipate a change in monetary policy early next year. Nearly two-thirds of economists surveyed by Reuters expect the Bank of Japan to abandon negative interest rates in the short term.

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