The inflation median forecast for 2024 was revised down to 1.9% from the previous 2%, while the 2025 forecast remains at 1.6%
Japan’s central bank, the Bank of Japan (BOJ), has recently made a significant policy change by loosening its yield curve control (YCC) mechanism. Concerns about the prolonged impact of monetary easing on financial markets and the real economy prompted the BOJ to adopt a more flexible approach.
Policy Change: A Flexible Approach
In a policy statement released after its July meeting, the BOJ announced its commitment to allow 10-year Japanese government bond (JGB) yields to fluctuate within a range of approximately plus and minus 0.5 percentage points from the 0% target level. This move effectively broadens the BOJ’s tolerance by an additional 50 basis points, signalling greater flexibility in its market operations.
The central bank emphasised the need to remain agile due to the “extremely high uncertainties” surrounding Japan’s economic activity and prices. BOJ Governor Kazuo Ueda clarified that the changes were not a step towards policy normalisation but aimed at enhancing the sustainability of YCC.
Market Reaction: A Delicate Balance
The years of accommodative monetary policy in Japan, in contrast to other global central banks tightening their policies, have led to carry trades being concentrated in the Japanese yen. The announcement triggered a sell-off in the 10-year JGB yields, reaching their highest levels since September 2014, while the yen experienced fluctuations against the dollar.
“It still seems likely that inflation will slow over the coming months as lower import prices weigh on goods inflation, which has accounted for the bulk of the recent acceleration in underlying inflation,” Marcel Thieliant, head of Asia-Pacific at Capital Economics, said in a note.
“If the economy enters a recession in the second half of the year as we anticipate, the case for policy tightening will diminish,” he added.
Despite initial market turbulence, the benchmark Nikkei and Topix stock indexes managed to recover before the close. Japanese bank shares rallied, with Mitsubishi UFJ surging 5.3% to its highest level in over 4½ years.
Governor’s Clarification: Maintaining a Dovish Stance
BOJ Governor Kazuo Ueda addressed speculations that the policy change represented a tightening of monetary policy. He asserted that the central bank’s current dovish position remains unchanged. The modification of the YCC framework was seen as a response to the stability in the bond market and the elevated uncertainty over Japan’s economic outlook.
“Letting yields move completely freely would essentially be abandoning YCC, and we’re not ready for that,” Ueda said. “We’d like to adjust the speed of yield moves and prevent speculative bond trading from spreading.”
Governor Ueda emphasised that controlling bond yields through market operations could stimulate the economy and support inflation, but it also comes with increasing side-effects. The BOJ sought to strike a balance by introducing greater flexibility in YCC.
Inflation and Economic Outlook: Patience Required
The BOJ’s quarterly outlook projected that the Japanese economy is likely to grow above its potential, primarily driven by increased consumer spending resulting from higher incomes. The central bank also noted positive changes in firms’ wage and price-setting behaviours.
Despite upward price pressures being underestimated, the BOJ maintains its prediction of a slowdown in inflation towards the end of the year. The inflation median forecast for 2024 was revised down to 1.9% from the previous 2%, while the 2025 forecast remains at 1.6%.
Balancing Act: Challenges Ahead
The BOJ’s decision to adopt flexibility in YCC comes in response to the evolving economic landscape. As the economy recovers from the impact of the pandemic and with inflation consistently exceeding the 2% target, the central bank faces challenges in striking the right balance between stimulating economic growth and managing side-effects.
Japan’s central bank, the BOJ, has taken a significant step towards adopting greater flexibility in its yield curve control. With uncertainties surrounding Japan’s economic activity and prices, the BOJ’s move seeks to maintain a cautious approach and pre-emptively address potential risks. While the initial market reaction was mixed, the long-term impact of this policy shift will be closely monitored to ensure sustainable growth and stability in the Japanese economy. As the country navigates through these challenges, the BOJ remains committed to its pursuit of achieving the 2% inflation target while supporting Japan’s economic recovery.
