Bank of Japan policymakers see little to cheer in successfully defending their yield target as European and U.S. central banks start to pull the plug on ultra-cheap money, casting doubt on the BOJ view that global bond yield gains will be short-lived.
Rising global yields forced the Japanese central bank to rev up bond buying last Friday to cap 10-year Japanese government bond (JGB) yields around its zero percent target, putting it at odds with its counterparts eyeing an exit from ultra-loose policy.
On top of an increase in regular bond buying, the BOJ offered to buy unlimited amounts of 10-year JGBs at 0.110 percent — employing its most powerful tool for only the third time since adopting yield curve control (YCC) in September.
With JGB yields having stabilised, policymakers say the step reminded investors that the BOJ won’t follow the U.S. Federal Reserve or European Central Bank in dialling back stimulus any time soon.
But Friday’s episode underscored the challenges the BOJ faces in battling market forces beyond its control.
By offering to buy at the same rate at which it intervened in February, the BOJ has effectively set a “line in the sand” that it may have to defend each time overseas forces drive up Japanese yields, say people familiar with the bank’s thinking.
That runs counter to the hope that many BOJ officials had to leave some flexibility on when and at what level the central bank steps in to defend its yield target.
“YCC is a difficult framework to manage. It’s fine when yields are low and stable, but that’s not always the case,” said one of the people, who spoke on condition of anonymity.
That view was echoed by two other people, with one saying: “It’s hard to know what could have happened if the BOJ waited a little longer before stepping in.”
Under YCC, the BOJ guides short-term rates at minus 0.1 percent and the 10-year JGB yield at around zero percent. It does not define what is considered “around” zero.
While BOJ officials say they won’t hesitate to step in for as much as needed to defend their yield target, doing so would also complicate the bank’s attempt to gradually whittle down its massive bond-buying program.
The key aim of adopting YCC was to shift the BOJ’s policy target to interest rates from the pace of money printing, as its huge bond buying was drying up liquidity and nearing its limit.
Having already gobbled up 40 percent of the entire bond market, the BOJ has been quietly slowing its purchases in what some analysts described as “stealth” tapering.
Ramping up bond buying again would severely distort market functions and makes a future exit from ultra-loose policy even more difficult, said former BOJ board member Sayuri Shirai.
“It’s necessary to taper the BOJ’s asset purchases to make its policy framework sustainable,” she said. “It’s pretty clear the merits of the current stimulus programme are diminishing and the costs rising.”
The BOJ was forced to increase buying three- to five-year JGBs on Wednesday as five-year yields hovered near 1-1/2 year highs.
Many BOJ officials say markets have over reacted to ECB President Mario Draghi’s signals of a gradual withdrawal of stimulus, and cling to hopes that the impact of global bond yield rises on Japan would be limited.
They argue that JGB yield gains won’t last unless driven by a pick-up in Japanese inflation, which remains elusive.
But there’s no guarantee global yield rises will be subdued, with the Bank of England and Bank of Canada joining others seeking to pull the plug on extraordinary monetary support deployed during the global financial crisis.
For the BOJ, raising the 10-year JGB yield would be hard to justify with inflation far from its 2 percent target, but allowing yields to deviate too far from its zero-percent target could cast doubt on its resolve to defend the target, and accelerate JGB yield rises.
“I can’t see how the BOJ can beat market forces when the global tide of central banking is towards normalisation,” said Mari Iwashita, chief market economist at SMBC Friend Securities.
Even if the BOJ were to ramp up bond buying to fight the market’s tide, it may face diminishing returns.
The more frequently it steps in, the BOJ could lose the “surprise” effect on markets, said Yusuke Ikawa, Japan strategist at BNP Paribas Securities.
“In the short term, the BOJ can make sure 10-year yields don’t rise if they get creative with their market operations, but if they buy too many bonds this year they could be in a tight spot next year.”
Frequent intervention may also draw international criticism as an attempt to intentionally weaken the yen, said Tsuyoshi Ueno, senior economist at NLI Research Institute.
“JGB yields may face upward pressure from overseas in a scale unprecedented since the adoption of YCC,” he said.
“Markets will begin testing the BOJ’s resolve if European and U.S. yields rise more. It will be crunch time for the BOJ.”