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Macroscope | Why Japan can’t afford to abandon its ultra-loose monetary policy
- The Bank of Japan’s decision to raise its bond yield cap has shocked markets, with many seeing the move as the start of policy normalisation
- In reality, the central bank has good reason to keep policy loose, but it will need to convince markets of that before they trigger a dangerous bond sell-off
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Just when investors thought 2022 could not possibly throw them any more curveballs, the Bank of Japan (BOJ) sprang a surprise. On December 20, it relaxed its “yield curve control” policy by lifting its cap on Japan’s 10-year bond yield to half a percentage point, double the previous upper limit.
In a world in which major central banks are jacking up borrowing costs by as much as three quarters of a percentage point in one go, the higher yield cap may seem like a minor adjustment in a country where interest rates have been in negative territory since 2016.
Yet, it is precisely because Japan remains an outlier in global monetary policy – and because the timing of the BOJ’s move was totally unexpected – that the tweak is all the more significant. At a time when markets are sensitive to shifts in policy and are inclined to overreact, the signal Japan’s central bank has sent is hugely consequential.
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The country’s 10-year bond yield experienced its sharpest daily rise in two decades following the BOJ’s announcement and currently stands just below the new 0.5 per cent cap. Moreover, speculative bets against the yen – one of the most popular trades in markets due to Japan’s negative rates which make the yen the preferred funding currency for so-called carry trades – are starting to lose their appeal.
The BOJ insists the adjustment was designed to make its yield curve control framework more sustainable. Yet, many investors view the tweak as the beginning of the end of the era of ultra-low rates in Asia’s second largest economy. Having withstood the dramatic rise in global bond yields this year, Japan, many believe, is finally caving to pressure to begin normalising policy.
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This could well be the case. Japan has looked ever more isolated as other economies raise rates aggressively. More worryingly, years of super-loose policy have grossly distorted asset prices, with the BOJ owning over half of Japan’s increasingly dysfunctional government debt market.
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