In December the Bank of Japan (boj) offered speculators an opening. By raising the cap on 10-year government bond yields from 0.25% to 0.5%, the central bank raised the prospect of abandoning its “yield curve control” policy entirely. Since then, officials have been tested by increasingly uncooperative bond markets. the boj was forced to make huge bond purchases to drive down the yield, buying 9.5 trillion on Jan 12-13 alone. yen ($72 billion).
Speculators eagerly awaited boj‘s next meeting. Would this be the moment for the central bank to give up the fight? On January 18th the boj announced that it would indeed continue. The bank even promised to buy more bonds if necessary. The yen plummeted on the news; Short sellers licked their wounds. But defending politics is becoming surprisingly expensive. the Youngs difficult decisions don’t go away
Yield curve control was introduced by the bank in 2016 as part of an aggressive monetary easing program it hoped would lift Japan’s dormant inflation and economic growth. the boj is one of the few central banks to have stayed on course in 2022 – neither raising interest rates nor halting large-scale asset purchases – as global inflation has risen.
Japanese inflation has also risen, but only to 4% yoy in December. That’s less than half the peak readings in America and the eurozone. And much of the rise is the result of the weak yen, which hit a 32-year low against the dollar in October, and high energy prices. And that’s how it happened boj argues that underlying inflation is yet to rise sustainably to its target level of 2%.
The central bank’s decision to remove the cap on bond yields in December was an attempt to improve liquidity and allow for more trading. It seems to have backfired. the boj owns around half of the country’s bond market and more than 95% of some bond issues after a decade of vigorous buying. Additional buying to defend the cap has exacerbated market tightness.
the Young‘s decision to hold could aggravate the situation. The central bank is building up huge potential losses in its bond portfolio. If Japanese bond yields rose by 0.25 percentage points, the bank’s total holdings would fall by about 7.5 trillion yen, or 1.4%, on Jan. 10 bip, according to our calculations. Each additional bond purchased to maintain the yield cap increases the potential loss.
Higher yields are also changing Japan’s fiscal arithmetic. The government’s net debt was about 173% bip the highest of any rich country in the third quarter of last year. About 8% of the state budget is spent on interest payments. If payments on the stock of government debt increased by the same amount – 0.25 percentage point – the total bill would be ¥11 trillion. or 10% of this year’s state budget. In the coming year, the Young doesn’t have good options. ■
