USD - Deeper into the Bank of Japan's yield curve control tweak

2023-07-28 06:23:15 ET

It's already been a big week for the world's biggest central banks, but the Bank of Japan had to get in on the action after a further round of rate hikes in the U.S. and Europe . The BOJ has remained an outlier on the world stage in the face of historic inflation, maintaining its easy monetary policy stance with its so-called Yield Curve Control. In fact, it's the only prominent central bank to still keep rates in negative territory, but signs of creeping price pressures, impacts on its balance sheet, and side effects of prolonged easing - like the weakening of the yen - mean the institution cannot continue down this path indefinitely.

Path toward normalization: The BOJ already widened its bands last December , allowing Japan's 10-year bond yields to rise to around 0.5%, or double the previous upper limit. Building on the steps, the central bank today kept the target for 10-year JGBs yields at around 0%, but said its 0.5% ceiling on yield movements was now a "reference" and "not a rigid limit." It will also offer to purchase Japanese government bonds in fixed-rate operations, effectively setting a new hard cap for the 10-year yield at 1%.

"Yield curve control is a dangerous policy which needs to be retired as soon as possible," said Kit Juckes, chief FX strategist at Societe Generale. "By anchoring JGB yields at a time when other major central banks have been raising rates, it has been a major factor in the yen reaching its lowest level, in real terms, since the 1970s. So, the BOJ wants to very carefully dismantle YCC, and the yen will rally as slowly as they do so. For the moment, that means there is little upside to USD/JPY, but the fall from here is also likely to be very slow, until the global trend in bond yields turns decisively lower."

Market movement: The timing of the tweak makes sense as things stabilize following the regional banking crisis in the U.S., while the end of an aggressive hiking cycle can also be seen on the horizon . Markets still had a hard time deciding on direction overnight, with the Nikkei 225 Index ( NKY:IND ) slumping to a session low of as much as 2.6% , before finishing the day down 0.5% . The yen ( JPY:USD ) was also volatile on the news, fluctuating between ¥138.6 to ¥140.4 against the dollar, while the benchmark 10-year JGB bond yield jumped to 0.575% - the highest level since September 2014 - before easing back.

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