The Bank of Japan on Tuesday shocked global markets by widening the target range for its 10-year government bond yield.
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The central bank caught markets off guard by tweaking its yield curve control (YCC) policy to allow the yield on the 10-year Japanese Government Bond (JGB) to move 50 basis points either side of its 0% target, up from 25 basis points previously, in a move aimed at cushioning the effects of protracted monetary stimulus measures.
In its policy statement, the BoJ said the move is intended to “improve market functioning and encourage a smoother formation of the entire yield curve, while maintaining accommodative financial conditions.”
The central bank introduced its yield curve control mechanism in September 2016, with the intention of lifting inflation towards its 2% target after a prolonged period of economic stagnation and ultra-low inflation. The introduction of YCC came after the Bank ran out of bonds to buy as part of its quantitative easing efforts, and was also response to yield curve distortions arising from negative rates.
The BoJ — an outlier compared with most major central banks — left its benchmark interest rate unchanged at -0.1% and vowed to significantly increase its rate of 10-year government bond purchases, retaining its ultra-loose monetary policy stance. In contrast, other central banks around the world are continuing to hike rates and tighten monetary policy aggressively in an effort to rein in sky-high inflation.
The YCC change prompted the Japanese yen and bond yields around the world to rise, while stocks in Asia-Pacific tanked. Japan’s Nikkei 225 was down 2.5% on Tuesday afternoon. The 10-year JGB yield briefly climbed to over 0.43%, its highest level since 2015.
Shares in Europe also retreated at the open, with the pan-European Stoxx 600 shedding 1% in early trade before recovering slightly. European government bonds also sold off, with Germany’s 10-year bund yield adding almost 9 basis points to 2.2840%.
“The decision is being read as a sign of testing the water, for a potential withdrawal of the stimulus which has been pumped into the economy to try and prod demand and wake up prices,” said Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.
“But the Bank is still staying firmly plugged into its bond purchase program, claiming this is just fine tuning, not the start of a reversal of policy.”
That sentiment was echoed by Mizuho Bank, which said in an email Tuesday that the market moves reflect a sudden flurry of bets on a hawkish policy pivot from the BoJ, but argued that the “popular bet does not mean that is the policy reality, or the intended policy perception.”
“Fact is, there is nothing in the fundamental nature of the move or the accompanying communique that challenges our fundamental view that the BoJ will calibrate policy to relieve JPY pressures, but not turn overtly hawkish,” said Vishnu Varathan, head of economics and strategy for the Asia and Oceania Treasury Department at Mizuho.
“For one, there was every effort made to emphasize that policy accommodation is being maintained, whether this was in reference to intended as well as potential step-up in bond purchases or suggesting no further YCC target band expansion (for now).”
The Bank of Japan noted in its statement that since early spring, market volatility around the world had risen, “and this has significantly affected these markets in Japan.”
“The functioning of bond markets has deteriorated, particularly in terms of relative relationships among interest rates of bonds with different maturities and arbitrage relationships between spot and futures markets,” it added.
The central bank said if these market conditions persisted, it could have a “negative impact on financial conditions such as issuance conditions for corporate bonds.”
“The Bank expects that the measures decided today will facilitate the transmission of monetary easing effects generated under the framework of yield curve control, such as through corporate financing,” it said.
“The Bank will aim to achieve the price stability target by enhancing the sustainability of monetary easing under this framework through implementing these measures.”