The Bank of Japan is under increasing pressure as it approaches its policy meeting next week. This pressure is coming from the need to reconsider its controversial bond yield control strategy due to rising global bond yields and ongoing inflation.
Recently, there has been a sharp increase in U.S. Treasury yields, which, in turn, has pushed up the 10-year Japanese government bond (JGB) yield. This JGB yield is getting close to the 1% limit set by the BOJ just three months ago. This situation is testing the bank’s determination to prevent a significant market-driven increase in borrowing costs.
The Bank of Japan’s decision to ease its control over long-term interest rates will be influenced by how the markets behave leading up to the meeting on October 30-31, as per sources.
Regardless of the decision next week, the BOJ is working towards eventually ending negative interest rates. Yasuhide Yajima, the chief economist at NLI Research Institute, mentioned that “Stocks are weakening now, so the BOJ might hold off next week. But if the markets stabilize, there’s a chance of action as early as December.”
During the upcoming meeting, it is widely anticipated that the BOJ will maintain its short-term rate target at -0.1% and the 10-year Japanese government bond (JGB) yield around 0%, as set under its yield curve control (YCC) policy.
The board of the Bank of Japan (BOJ) might have a discussion about the 1% limit that they set for the 10-year yield. Keeping it as it is could mean they have to increase bond purchases and expand their already large balance sheet, according to analysts.
Exiting the current situation is tricky for the BOJ due to various factors. They have a dovish stance, which makes them different from many other central banks globally that have been raising rates aggressively to tackle high inflation. Inflation in Japan has remained above the BOJ’s 2% goal for 18 consecutive months as of September. Surveys indicate rising inflation expectations, which reduce the actual cost of borrowing even if nominal interest rates stay the same.
Next week, the BOJ is expected to revise its forecasts to show that inflation will reach or surpass the 2% target for this year and the next. Additionally, the weak yen, which has been blamed for increasing the cost of imported food and fuel for households, is also putting pressure on the BOJ to close the gap between U.S. and Japanese interest rates.
BOJ Governor Kazuo Ueda has consistently stated that an early exit from the current monetary policy is not on the table. He has emphasized the risks associated with the global economic slowdown and the uncertainty surrounding next year’s wage prospects.
It’s not entirely clear how Prime Minister Fumio Kishida’s government views the current monetary policies. While higher Japanese interest rates could help stabilize the yen’s value, they may also lead to increased mortgage rates and borrowing costs for small businesses trying to recover from the pandemic.
The government is working on a financial relief package to mitigate the economic impact of rising living expenses, with the aim of achieving sustainable growth and overcoming deflation.
Chief Cabinet Secretary Hirokazu Matsuno has expressed expectations that the BOJ will collaborate closely with the government in shaping policy. However, it seems that both the financial markets and the government are preparing for a potential near-term policy shift. This is supported by mounting evidence that the BOJ is quietly preparing for a change, including its decision to raise the yield cap in July and signals that Japan is moving away from its deflationary mindset.
Prominent financial institutions, including Japan’s Dai-Ichi Life Insurance, anticipate a change in the BOJ’s policy in the early part of next year. Additionally, nearly two-thirds of economists surveyed by Reuters predict that the BOJ will discontinue negative interest rates next year.
A government official with regular contact with the BOJ, speaking on condition of anonymity due to the sensitive nature of the issue, remarked, “The BOJ will eventually phase out negative rates and yield curve control (YCC). The only uncertainty is when it will happen.”
