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BOJ Signals Flexibility on Yield Curve Control

Bank of Japan Moves Closer to Normalization with Loosening of Yield Curve Control

What is Yield Curve Control

The central bank basically buys Japanese government bonds whenever the 10-year yields risk going beyond the 0.5% allowable range or below zero.  This YCC (Yield Curve Control) policy is able to keep the 10-year rates within a band of 0 to 0.5%.

In December of 2022, the ceiling was raised by 0.25% with resulting rates rising to about 0.44%.  However, inflation and rate hikes by other major central banks like the FED, ECB and BOE put pressure on the 0.5% ceiling.

Why Does this Matter for Financial Markets

Ueda, Governor of the Bank of Japan, with this policy meeting signals an end or slow end to monetary easing and a return to normalization.  The committee voted 8-1 in favor of allowing more flexibility with the YCC band.

The financial market was confused by what this means exactly.  The Japanese YEN initially strengthened yesterday but as the market deciphered the policy action the Japanese YEN weakened again.  In short, the ‘flexibility’ means the BOJ will step in to a certain extent, still unknown, when the 10-year rate rises to between 0.5% to 1.0%.  In short, the upper cap is being moved from 0.5% to 1% gradually.

Thus, the market does not see this at the moment as a fundamental-driven policy change which means no significant pressure on the YEN to appreciate.  It should be noted that BOJ has other tools to control the YCC band such as short selling and long-term fund supply program designed to encourage purchases.

However, if inflation continues this flexibility means that the BOJ will need to eventually push the band to 1% eventually.  The policy statement today gives Japan’s Central Bank this option.

Compared with other economies, the rates in Japan are low thus making the Japanese YEN a funding currency for the carry-trade.

The implications for the carry-trade being over in our opinion are not there yet.  The BOJ was transparent by telling the market, especially in Japan, that something was coming. Additionally, the repatriation flows from Aussie, British and US rates are not happening to a significant extent yet.