Japan: BoJ tweaks YCC – Global bond market takes a hit

• Bank of Japan (BoJ) surprised the market this morning by raising the upper band on its yield curve control (YCC) policy from 0.25% to 0.50%.

• Bond yields in Japan rose on the news with spillover to global bond markets and the Danish callable bond market. USD/JPY dropped to 132 on the move.

• We expect a policy rate hike to 0% in Q2 followed by a 25bp increase in the yield target to 0.25% and an increase in the fluctuation band from -0.25% to 0.75%.

In a surprise move, BoJ adjusted its yield curve control this morning. BoJ widened the band around its 10-year 0% yield target to +/-50bp from +/-25. The official explanation is that it will allow for a smoother formation of the yield curve. The move comes with a pledge to sharply increase bond buying, in order to stress that this is a fine-tuning move and not tightening. At the press conference, governor Kuroda also did his best to communicate that it is not a tightening move.

Inflation has picked up in Japan, but it remains an imported phenomenon. Service inflation, for instance, is on the rise, but still stands at just 0.8%. An increase in wage pressure is key for BoJ to achieve its goal of reflating the economy permanently. It remains our base case that a global recession will obstruct a significant increase in wage pressure. However, we see a risk that a new governor will differentiate less between domestically created inflation and imported inflation and will use this opportunity to modify BoJ’s extreme position among global central banks – it is the only major central bank left with an easing stance.

Spring will be crunch time in Japan with the annual wage negotiations and a scheduled replacement of all three governors in BoJ. Based on today’s move, we think the probability of further moves next year has increased and we expect a move away from negative interest rates after a new governor has been appointed, followed by a further loosening of the yield curve control. Specifically, we expect a policy rate hike to 0% in Q2 followed by a 25bp increase in the yield target to 0.25% and an increase in the fluctuation band from -0.25% to 0.75%.

After the announcement today the market has started to position for a possible rate hike from BoJ. The market now discounts a full 10bp interest rate increase by April, which would take short-term Japanese interest rates back to zero and a full 25bp interest rate increase by August. Yesterday, the market did not expect a full 25bp increase until November, i.e. the market expects a possible rate hike in Japan to be a theme for H1 next year.

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