By Leika Kihara
TOKYO (Reuters) – A recent surge in global interest rates is heightening pressure on the Bank of Japan to change its bond yield control next week, with a hike to an existing yield cap set just three months ago being discussed as a possibility. Any decision to change its yield curve control (YCC) will largely depend on how markets move leading up the Oct. 30-31 policy meeting, three sources familiar with the matter told Reuters, speaking on condition of anonymity due to the sensitivity of the matter.
The sources said there is currently no consensus within the central bank on whether an immediate change to YCC is necessary. The BOJ remains a global outlier having maintained ultra-loose monetary stimulus even as major central banks elsewhere rapidly raised interest rates to fight rampant inflation. The widening policy gap between Japan and its peers has weighed heavily on the yen, which has in turn fanned imported inflation. Meanwhile, rising U.S. bond yields are pulling their Japanese counterparts higher, complicating the BOJ’s task of keeping local interest rates low. “It’s true Japanese long-term interest rates are rising more than expected,” said one of the sources. “Depending on market developments, it can’t be ruled out,” the source said on the chance of debating further tweaks to YCC this month, a view echoed by two more sources.
As part of efforts to reflate growth and sustainably hit its 2% inflation target, the BOJ uses YCC to guide the 10-year Japanese government bond (JGB) yield around 0%. In July, it raised the de-facto cap on the yield to 1.0% from 0.5% to allow long-term rates to rise more reflecting increasing inflation. However, discussions surrounding the fate of yield curve control (YCC) will likely intensify as rising inflation heightens market expectation of a gradual phase-out of the BOJ’s massive stimulus. Among ideas that could be discussed would be to raise the ceiling for the 10-year bond yield beyond 1.0%, or steps that water down the BOJ’s commitment to defend a set yield level, the sources said. The BOJ did not reply to a Reuters request for comment.
Given uncertainty over the outlook for global growth and next year’s wage expectations, however, some in the BOJ are opposed to taking steps that would be interpreted as a move toward an exit from ultra-loose policy, the source said. A spike in U.S. Treasury yields pushed the 10-year JGB yield to a decade-high of 0.855% on Monday, approaching what Governor Kazuo Ueda described in July as a “precautionary” ceiling of 1% that was highly unlikely to be breached. The Nikkei newspaper reported on Sunday tweaks to YCC, such as raising the 1% ceiling or removing the allowance band set around the 0% target, are emerging within the BOJ as possible options for this month’s meeting.
While raising the cap would allow the BOJ to avoid ramping up bond buying and dry up already thinning market liquidity, doing so could push the yield further away from the 0% target, casting doubt on the feasibility of YCC. Responding to yield rises driven predominantly by external market moves would also run counter to the BOJ’s pledge to keep ultra-low rates until domestic demand and wages strengthen enough to keep inflation sustainably around its target. While the BOJ is likely to hold off ending negative rates or dismantling YCC altogether, it may be compelled to tweak the framework again depending on market moves, some analysts say.
“Whether the BOJ will tweak YCC again will depend on market moves ahead of the October meeting,” said Naomi Muguruma, senior market economist at Mitsubishi UFJ (NYSE:MUFG) Morgan Stanley Securities. “If the 10-year JGB yield rises to around 0.9%, the BOJ may need to take action,” such as by raising the 1% cap, she added. While the BOJ is seen upgrading its inflation forecasts in fresh quarterly projections due on Oct. 31, Ueda has pledged to keep ultra-loose policy until he sees solid consumption and wage growth. In a Reuters poll in September, most analysts said they expect the BOJ to abandon YCC by the end of 2024. A majority of them also project an end to negative rates next year.
