Commentator – How does Japan’s yield curve control work?

TOKYO: The Bank of Japan’s Yield Curve Control (YCC) has come under fire from the market as investors test the Bank of Japan’s efforts to cap bond yields with inflation above its target.

The BOJ’s ultra-loose policy is to keep some short-term interest rates at -0.1% and 10-year JGB yields at 0.5% above or below zero to sustainably achieve 2% inflation. is the goal.

Here we explain how the Japanese YCC works and potential pitfalls.

Why Choose YCC

The market is currently testing the BOJ’s bond yield target higher, but when it adopted the YCC in 2016, the BOJ was trying to keep rates from going too low.

After years of huge bond purchases failed to spur inflation, the Bank of Japan cut short-term interest rates below zero in January 2016, fending off an undesired appreciation of the yen. The move crushed yields across the yield curve and enraged financial institutions that saw investment returns evaporate.

To raise long-term interest rates, the Bank of Japan adopted the YCC eight months later, adding a 0% target for 10-year JGB yields to its short-term interest rate target of -0.1%.

The idea was to control the shape of the yield curve in order to limit the short- and medium-term interest rates that affect corporate borrowers without pushing super long-term yields too far, reducing returns for pension funds and life insurance companies.

How does it work?

The Bank of Japan chose the interest rate regime because it had reached the limit of quantitative easing. There, they bought target amounts of government bonds to push yields down in hopes of stimulating inflation and economic activity.

When the central bank swallowed half of the bond market, it was difficult to commit to buying at the set pace. allowed.

Banks cut bond purchases during periods of calm markets to lay the groundwork for an eventual end to ultra-accommodative policy.

Why Target Band?

Stubbornly low inflation forced the BOJ to hold on to YCC longer than expected, so bond yields began to stay in a tight range and trading volumes fell.

To combat such side effects, the Bank of Japan announced in July 2018 that the 10-year yield could move up or down by 0.1%. In March 2021, the bank widened its bands to his 0.25% in both directions to revive a market paralyzed by buying.

Under fire from investors betting on rate hikes, the Bank of Japan doubled its bandwidth from 0.5% to 0.5% in December and increased bond purchases to defend the cap.

Investors broke the 0.5% cap on Friday, fueling expectations that the BOJ must take more drastic steps.

Pitfall?

The YCC worked well when inflation was low and the Bank of Japan’s price target was unlikely to be met.

But as inflation erodes those gains, investors are selling bonds and pricing in the possibility of a short-term rate hike.

The Bank of Japan has increased buying, such as through offers to buy unlimited amounts of bonds, to protect the yield cap. This has been criticized by analysts for distorting market pricing and fueling an unwanted plunge in the yen that drives up the cost of importing raw materials.

Turning point?

Bank of Japan, plagued by a politically overheated history of prematurely tapering stimulus, reveals inflation will sustainably hit BOJ’s 2% target and wage growth will accelerate We want to avoid rate hikes until

However, the market could force the BOJ to ease, which could topple the 10-year yield on Friday. This was before interest rates were cut again by a large BOJ bond purchase. Investors may continue to short Japanese government bonds this week in anticipation of a short-term rate hike.

If the attacks on the market continue, the BOJ could take more drastic steps, such as broadening its yield target range further, raising its long-term interest rate target or abandoning it entirely, some analysts said. I’m here.