The Bank of Japan (BOJ) is anticipated to retain its negative interest rate policy this week, drawing attention to the possibility of tweaking its cap on benchmark yields. Governor Kazuo Ueda, who assumed office in April, has consistently expressed doubts about the sustainability of recent price growth in Japan, setting the BOJ apart from major peers who have aggressively increased rates to address inflation concerns. While both the Federal Reserve and the European Central Bank are expected to hike rates before the BOJ’s decision on Friday, the focus remains on whether the BOJ will make adjustments to its yield curve control (YCC) in response to price surges.
Despite Governor Ueda’s determination to maintain stimulus measures, Japan continues to experience price growth well above 3%, leaving the BOJ with no option but to raise its inflation forecast for this fiscal year during this week’s meeting. This anticipated upward revision has fueled speculation about the potential adjustment or elimination of YCC.
Informed sources suggest that BOJ officials may consider raising their inflation forecast for this year from 1.8% to around 2.5%. However, a Bloomberg report indicates that while there is no immediate need to tweak YCC in July, the topic is likely to be discussed during the meeting.
Market economists expect Governor Ueda to adopt a cautious stance against early YCC adjustments, as he believes that closely monitoring upside inflation risks and downside economic risks is essential at this stage. A Bloomberg economist, Taro Kimura, emphasized that any modifications to YCC now might damage Ueda’s reputation as a clear communicator, considering his consistent stance on the need for continued stimulus.
Governor Ueda has repeatedly warned against premature tightening that could harm the nascent inflation progress. Based on his past voting record when he was a board member, Ueda is likely keen to avoid repeating the mistake of acting too early.
While economists generally agree that a change to the BOJ’s minus 0.1% short-term interest rate is not imminent, there is ongoing debate about the timing of adjustments or the removal of the 0.5% cap on 10-year government bond yields.
The BOJ’s strategy of keeping yields low is aimed at stimulating economic activity and prices, despite complaints from bond traders about market pricing distortions. Currently, the yield curve does not exhibit significant distortions, unlike in December. Benchmark yields have consistently remained below the BOJ’s ceiling, and the central bank has not needed to purchase additional bonds to defend its cap in recent months.
The BOJ faces the challenge of balancing its communication regarding the achievement of its 2% inflation target. Some analysts propose that this might be an opportune moment to tweak YCC while the pressure on the yield cap is less intense. Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management, suggests that such a move would ease pressure on the yen, moderately increase benchmark yields toward 1%, and alleviate distortions in the bond market. If the BOJ does not act this week, investors should consider the possibility of YCC changes in subsequent meetings throughout the year.
Former BOJ deputy governor Masuzumi Wakatabe highlights that speculators focusing on possible YCC tweaks might be missing the more critical point of when the BOJ will feel confident in achieving its 2% inflation target. As the BOJ faces a communications challenge, the main message regarding inflation progress remains crucial.