scorecardresearchExplained: Bank of Japan surprises markets with its policy tweak; What does it mean?

Explained: Bank of Japan surprises markets with its policy tweak; What does it mean?

Updated: 21 Dec 2022, 01:17 PM IST
TL;DR.
BoJ had set a target range around zero for the benchmark government-bond yield, or 10-year bond-yield, since 2016. While earlier the long-term interest rates on 10-year bonds were capped at 0.25 percent, that cap is now 0.5 percent.
BoJ's move has a clear signal that the era of negative yields is closer to an end in the world.

BoJ's move has a clear signal that the era of negative yields is closer to an end in the world.

Experts felt 'stunned', 'surprised' and 'shocked' after an unexpected policy tweak by the Bank of Japan (BoJ) on December 20.

Not a single one of 47 economists polled by Bloomberg expected a change in policy at this meeting. But Japan's central bank surprised the world.

In a policy statement on December 20, the BoJ signalled the widening of its target band for interest rates after it said it would allow yields on 10-year government bonds to move up or down within 50 basis points around its zero percent target, wider than the previous 25-point band.

BoJ had set a target range around zero for the benchmark government-bond yield, or 10-year bond yield, since 2016. While earlier the long-term interest rates on 10-year bonds were capped at 0.25 percent, that cap is now 0.5 percent.

However, Japan’s interest rates are still lower than the rates in the US and Europe, largely because its inflation rate has not soared as high. Nevertheless, Japan has seen prices rise as an after-effect of the Ukraine war and the yen’s weakness.

On December 14, the Federal Reserve raised its policy rates by 50 bps to a range between 4.25 percent and 4.5 percent which is a 15-year high, and projected rates would end next year at 5.1 percent before being cut to 4.1 percent in 2024.

The Bank of England and the European Central Bank also raised interest rates by a half-percentage point, or 50 bps, each.

What does it mean for investors?

The move of BOJ has no direct ramifications on the Indian market but it does signal that the war against inflation is a global phenomenon at this point in time.

Alice Rivlin, an American economist and former Vice Chair of the Federal Reserve, once said: "The job of the central bank is to worry."

Inflation is the biggest worry of central bankers across the globe.

Deepak Jasani, Head of Retail Research at HDFC Securities pointed out that Japan is among the last central banks to turn hawkish. Its dovish stance so far helped to keep borrowing costs at low levels more broadly.

Jasani believes the tightening of domestic financial conditions may result in a wave of capital returning home which threatens to push down asset prices and boost global borrowing costs at a time the economic outlook is deteriorating. This will also strengthen the yen versus other currencies including the dollar which may become a self-fulfilling prophecy of more yen strength.

"Investors are expected to exit bonds in the US, Australia and France, and developed-market equities are also likely to decline. Indian markets though not immediately impacted, could face second-order consequences of a selloff in the developed markets after a few weeks," said Jasani.

Experts point out that a collective effort by the global central banks to tighten monetary policy will ease inflationary pressures sooner and more effectively.

There is also a clear signal that the era of negative yields is closer to an end in the world.

"What we are looking at is a reexamination of the efficacy of ultra-loose monetary policy, and the BoJ is the last skittle to fall in all of this. I hope this is the end of negative rates because it might mean we’re going to stop relying on central banks to do everything. We now know that negative rates don’t work, full stop," Bloomberg quoted Stephen Miller, a former head of fixed income at ­BlackRock Inc, saying so.

Reuters quoted Kheng Siang NG, Asia Pacific head of fixed income at State Street Global Advisors, Singapore, saying that BoJ's move signals the beginning of the slow unwind of ultra-low interest rates in Japan and the change in YCC (yield curve control) range will help reduce the bond market from being artificially held up by central bank bond purchases and improve secondary trading liquidity.

"The timing of the policy tweak is a surprise, though we have been expecting the move to come in 2Q 2023. The tweak may seem modest but is significant for a central bank that has held dovish for a long time. The implication is a modest improvement from wide UST-JGB yield differentials ... and a moderate-to-softer USD profile can lead to further downside in USDJPY," Reuters quoted Christopher Wong, Currency Strategist at OCBC Bank, Singapore, saying so.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie. Some parts of this article have been taken from wire agency feed.

Article
These are the RBI's monetary policy instruments.
First Published: 21 Dec 2022, 01:17 PM IST