Chart of the Week: Bank of Japan’s risky game

Yields on Japanese ten-year government bonds have reached their highest level in nine years, currently at 0.641% as of 7 August, up from 0.438% ten days earlier. The surge began on 28 July when the Bank of Japan (BoJ) unexpectedly altered its strict yield curve control (YCC) policy. The harsh 0.5% upper limit on bond yields that the Bank had previously enforced will now instead be viewed as a “reference”, and the BoJ will be buying ten-year Japanese government bonds at 1%. The BoJ has faced increased pressure this year to reduce its ultra-loose monetary policy stance, as inflation reached 3.87% in January — highs not seen in Japan since the early 1980s — and as the Japanese yen has been losing value quickly due to the widened yield gap between Japan and many other advanced economies. The BoJ has stated however that it is not changing its negative policy rate: a reluctance deep-rooted in Japan’s deflationary history. Moreover, the BoJ seems persuaded that the current bout of inflation is driven more by higher import prices than strong demand, and indeed seems implicitly to place a lot of faith in inflation being a temporary phenomenon. Higher import prices are increasingly less driven by global supply constraints and increasingly more by a weaker yen. The partial easing of the YCC policy is likely to alleviate some of the pressure on the yen; but not by much, as foreign monetary policy decisions, particularly in the US, will continue to be an important driver of import prices and inflation. Fathom expects the Fed to be close to a peak in its monetary policy cycle. Significant risks remain, however — risks that the BoJ continues to be reactive towards, a risky game indeed.

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