BoJ sticks to loose monetary policy sending yen sharply lower

The Bank of Japan has renewed its pledge to keep bond yields at zero, widening its policy gap with the central banks of other major economies that are raising interest rates to tame surging inflation.

The BoJ’s decision to stick to its ultra-loose monetary policy exacerbates a global divergence in yields after the Federal Reserve raised its main interest rate by a historic 0.75 percentage points this week, prompting Switzerland and the UK to also raise rates.

The BoJ on Friday kept overnight interest rates at minus 0.1 per cent. It said it would conduct daily purchases of 10-year bonds at a yield of 0.25 per cent, showing no willingness to let bonds trade in a wider band.

Japan’s core consumer prices, which exclude volatile food prices, have risen at their fastest pace in seven years due to soaring commodity prices. But the BoJ has long argued that underlying demand in the economy remains weak.

The central bank has greater confidence than its counterparts in Europe and the US that the current bout of inflation will be transitory and that it needs to continue supporting the economy with monetary easing measures.

“There remain extremely high uncertainties for Japan’s economy,” the BoJ said in a statement, citing Covid-19 disruptions, the war in Ukraine and rising import costs of commodities and other goods.

“In this situation, it is necessary to pay due attention to developments in financial and foreign exchange markets and their impact on Japan’s economic activity and prices.”

The decision triggered a sharp dip in the yen to ¥134.28 against the dollar, extending what has been a phase of exceptionally volatile trading.

Ahead of the announcement, some analysts had forecast that BoJ governor Haruhiko Kuroda might seek to address the recent plunge in the yen with a small tweak in policy. When that did not happen, traders in Tokyo said that the yen may have further to fall.

Benjamin Shatil, forex strategist at JPMorgan in Tokyo, said the decision showed the BoJ “digging its heels in once again”. But he noted that the bank appeared to harden its tone slightly by saying it would pay due attention to developments in financial and foreign exchange markets.

The implication for the yen, he said, is that a move into the high ¥130s against the dollar is now in plan sight, and it could even hit ¥140.

“With the BoJ apparently impervious to the wave of hawkish global central bank capitulation, unconcerned about broadening imported price pressures in Japan, and apparently willing to purchase the entire stock of [10-year Japanese government bonds] if necessary to preserve yield curve control, pain for the yen looks set to go from acute to chronic,” said Shatil.

The BoJ’s decision comes as trading in JGBs continued to mount a direct challenge to the central bank’s resolve, in particular to its commitment to maintain yield curve control by keeping yields on the benchmark 10-year note within 0.25 per cent either side of zero.

After that line was repeatedly breached this week, the BoJ stepped in with massive purchases of JGBs on top of the standard offer of unlimited daily buying that it uses to reassure the market of its commitment to the policy.

On Friday morning, the 10-year JGB yield touched 0.265 per cent, marking its highest level since January 2016.