BoJ meets: Is another yield curve tweak on the cards? – Preview
October 27, 2023 10:25 am
Speculation of a BoJ policy tweak in October is mounting
Will the BoJ raise the 10-year yield cap and would this boost the yen?
Decision is expected on Tuesday, October 31
BoJ expected to raise inflation outlook
The Bank of Japan will conclude its two-day monetary policy meeting on Tuesday and is widely anticipated to revise up its inflation forecasts in its updated outlook report. The bigger question, however, is whether any changes to the CPI forecasts will be complemented by a policy response. Rumours are swirling that the BoJ will debate adjusting its yield curve control (YCC) again, having last tweaked it not so long ago in July.
Pressure is building on policymakers to abandon the controversial policy that has kept the Bank of Japan active in the bond market even as other central banks have begun reducing their balance sheets. There are two fronts to the urgency to widen the target band on the 10-year yield that’s currently set around zero.
Inflation is easing, for now
The first is inflation, and officially, this is the main benchmark policymakers look at when setting policy. So where do things stand on the price outlook? According to BoJ sources, the Bank will likely lift its inflation projections for the next two fiscal years, increasing them to around 3.0% for 2023 and at or above 2.0% for 2024.
The significance of this is that it would enable policymakers to make a stronger case that the rise in inflation is becoming more sustainable, thereby meeting a key criterion for exiting stimulus. But by how much inflation forecasts will be revised higher is questionable after CPI excluding fresh foods fell below 3.0% in September for the first time since August 2022. Moreover, wage growth, which is a vital component for keeping inflation at the 2% target in a sustainable manner has been weakening in recent months.
Hopes of wage growth picking up
However, there are signs that both inflation and earnings growth could re-accelerate over the coming months. For example, CPI excluding energy as well as food prices is still running above 4.0%, while another measure that is a weighted median and is watched closely by the BoJ just hit 2.0% for the first time in the series’ history.
As for wages, there’s been disappointment that this year’s round of wage negotiations didn’t generate a broader trend of big pay increases across Japan. But there’s hope that there’s more to come as several big companies in the country have indicated they are willing to offer pay deals of at least 5.0% next year – something supported by improving business optimism.
Will BoJ raise the yield cap again?
With all this in mind, policymakers may feel more confident about removing some stimulus from the economy by allowing the yield on 10-year JGBs to rise above the current hard cap of 1.0%. But is this the only reason that the Bank is getting itchy about normalizing policy sooner rather than later?
The purpose of the tweak in July when the target band was effectively doubled was to make the policy more sustainable. But it didn’t take long for investors to push yields closer to the upper bound, as Japanese sovereign bonds have been caught up in the global bond rout that’s pushed US yields to pre-financial crisis levels.
Yen pinned down by low yields
Subsequently, the BoJ regularly has to step in the bond market for unscheduled JGB purchases to prevent the 10-year yield from rising too fast, each time kneecapping the yen in the process. The widening yield differentials have become a major drag on the yen, especially against the US dollar, and although the BoJ isn’t particularly concerned about a weaker exchange rate, the government is.
But would raising the yield cap again alleviate these side effects when the impact of the previous tweaks was short lived? Another option is to raise interest rates and there is some speculation that the Bank is getting closer to exiting negative interest rates. But whilst shock decisions can never be ruled out when it comes to the BoJ, this is probably more of a 2024 story and sticking with YCC adjustments seems like the most likely outcome for now.
Doubts about yen boost from change in yield target
If policymakers decide in favour of widening the band around its yield target, the yen could immediately jump towards its 50-day moving average in the 148 per dollar region. However, further gains would depend on whether any policy shift is backed up by hawkish rhetoric, which seems unlikely. Nevertheless, there is scope for any correction in dollar/yen to stretch until the 145 level near the June top.
In the event that the Bank disappoints and leaves policy unchanged, the yen could under renewed pressure, weakening further past the critical 150 mark. Any move by the dollar towards the 151 handle would increase the risk of intervention by Japanese authorities.
Speculation of a BoJ policy tweak in October is mounting
Will the BoJ raise the 10-year yield cap and would this boost the yen?
Decision is expected on Tuesday, October 31
BoJ expected to raise inflation outlook
The Bank of Japan will conclude its two-day monetary policy meeting on Tuesday and is widely anticipated to revise up its inflation forecasts in its updated outlook report. The bigger question, however, is whether any changes to the CPI forecasts will be complemented by a policy response. Rumours are swirling that the BoJ will debate adjusting its yield curve control (YCC) again, having last tweaked it not so long ago in July.
Pressure is building on policymakers to abandon the controversial policy that has kept the Bank of Japan active in the bond market even as other central banks have begun reducing their balance sheets. There are two fronts to the urgency to widen the target band on the 10-year yield that’s currently set around zero.
Inflation is easing, for now
The first is inflation, and officially, this is the main benchmark policymakers look at when setting policy. So where do things stand on the price outlook? According to BoJ sources, the Bank will likely lift its inflation projections for the next two fiscal years, increasing them to around 3.0% for 2023 and at or above 2.0% for 2024.
The significance of this is that it would enable policymakers to make a stronger case that the rise in inflation is becoming more sustainable, thereby meeting a key criterion for exiting stimulus. But by how much inflation forecasts will be revised higher is questionable after CPI excluding fresh foods fell below 3.0% in September for the first time since August 2022. Moreover, wage growth, which is a vital component for keeping inflation at the 2% target in a sustainable manner has been weakening in recent months.
Hopes of wage growth picking up
However, there are signs that both inflation and earnings growth could re-accelerate over the coming months. For example, CPI excluding energy as well as food prices is still running above 4.0%, while another measure that is a weighted median and is watched closely by the BoJ just hit 2.0% for the first time in the series’ history.
As for wages, there’s been disappointment that this year’s round of wage negotiations didn’t generate a broader trend of big pay increases across Japan. But there’s hope that there’s more to come as several big companies in the country have indicated they are willing to offer pay deals of at least 5.0% next year – something supported by improving business optimism.
Will BoJ raise the yield cap again?
With all this in mind, policymakers may feel more confident about removing some stimulus from the economy by allowing the yield on 10-year JGBs to rise above the current hard cap of 1.0%. But is this the only reason that the Bank is getting itchy about normalizing policy sooner rather than later?
The purpose of the tweak in July when the target band was effectively doubled was to make the policy more sustainable. But it didn’t take long for investors to push yields closer to the upper bound, as Japanese sovereign bonds have been caught up in the global bond rout that’s pushed US yields to pre-financial crisis levels.
Yen pinned down by low yields
Subsequently, the BoJ regularly has to step in the bond market for unscheduled JGB purchases to prevent the 10-year yield from rising too fast, each time kneecapping the yen in the process. The widening yield differentials have become a major drag on the yen, especially against the US dollar, and although the BoJ isn’t particularly concerned about a weaker exchange rate, the government is.
But would raising the yield cap again alleviate these side effects when the impact of the previous tweaks was short lived? Another option is to raise interest rates and there is some speculation that the Bank is getting closer to exiting negative interest rates. But whilst shock decisions can never be ruled out when it comes to the BoJ, this is probably more of a 2024 story and sticking with YCC adjustments seems like the most likely outcome for now.
Doubts about yen boost from change in yield target
If policymakers decide in favour of widening the band around its yield target, the yen could immediately jump towards its 50-day moving average in the 148 per dollar region. However, further gains would depend on whether any policy shift is backed up by hawkish rhetoric, which seems unlikely. Nevertheless, there is scope for any correction in dollar/yen to stretch until the 145 level near the June top.
In the event that the Bank disappoints and leaves policy unchanged, the yen could under renewed pressure, weakening further past the critical 150 mark. Any move by the dollar towards the 151 handle would increase the risk of intervention by Japanese authorities.
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