The Bank of Japan faces more tests to control yields as inflation picks up

TOKYO (Reuters) – The Bank of Japan is likely to raise its inflation forecast next week and discuss whether more steps are needed to address market distortions, which it sought to fix with a surprise December adjustment of its yield control policy, sources said. .

The Bank of Japan’s decision last month to widen the band around its 10-year yield target failed to remove market distortions caused by its massive bond purchase, leaving traders speculating whether more steps could be taken early in its January 17-18 rate review.

While distortions may be among the topics of discussion at the Jan. 17-18 meeting, many BoJ officials would prefer to spend more time scrutinizing the impact of the December decision, said five sources familiar with the bank’s thinking.

The sources said that the Central Bank is keen to wait for more clarity on whether wage increases will expand or not, and is also seen to postpone making major adjustments to control the yield curve, such as abandoning negative interest rates.

“Japan has yet to see stable and sustained inflation that meets the bank’s 2% target,” said one of the sources.

“The key will be the outcome of wage negotiations in the spring, and whether wage increases will continue as a trend,” another source said of when the BoJ could move towards phasing out the YCC.

At next week’s meeting, the Bank of Japan is widely expected to leave its targets unchanged, set at -0.1% for short-term interest rates and around 0% for the 10-year yield.

The Bank of Japan surprised markets last month by widening the range it set around its 10-year yield target, a move it described as intended to mitigate the rising cost of prolonged easing.

Under the newly defined range, it is now allowing the 10-year yield to rise to 0.5%, which is the level the markets are currently testing. Many market players saw December’s decision as a precursor to a near-term interest rate hike, a view rejected by Governor Haruhiko Kuroda.

In new quarterly forecasts due after the meeting, sources told Reuters, the central bank is likely to raise its inflation forecast, in a sign of its growing conviction that conditions may gradually ease to restore stimulus.

With accelerating inflation putting upward pressure on long-term interest rates, some analysts are betting that the Bank of Japan can widen the range and allow the 10-year yield to rise by as much as 0.75%.

The yen jumped and the 20-year Japanese government bond yield rose to an eight-year high of 1,400% on Thursday after Japan’s Yomiuri newspaper reported that the Bank of Japan may take additional steps next week to address the side effects of monetary easing.

The sources said that many BoJ officials are wary of widening the range for fear that this could be interpreted as a signal that the central bank is losing control of the yield curve, and casts doubt on the viability of the YCC.

However, some economists are already predicting the end of YCC as Governor Haruhiko Kuroda’s term expires in April.

“It is likely that the Bank of Japan will expect inflation to reach 2% in fiscal 2023 at next week’s meeting, so that it can justify tweaking the YCC as early as April,” said Yasuhide Yajima, chief economist at NLI Research Institute.

“Instead of widening the range again, the Bank of Japan could abandon its 10-year yield target later this year and commit to flexibly buying bonds to avoid any sudden spike in borrowing costs.”

(Reporting by Leika Kihara). Editing by Kim Coghill

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