BOJ widens 10y yield band

The BOJ surprisingly added more flexibility to its YCC program at its 19-20 December Monetary Policy Meeting (MPM). Specifically, it widened its 10y JGB yield band from ±25bp to ±50bp while leaving its 10y yield target unchanged at 0%. Additionally, the BOJ reiterated its commitment to keeping the 10y yield from rising above its trading band’s 0.5% ceiling by maintaining an open-ended bid to purchase 10y JGBs at a 0.5% yield every trading day.

The BOJ explained that it decided to adjust its YCC policy settings to improve market function and rectify yield curve distortions while maintaining accommodative financial conditions. In other words, the BOJ took action to mitigate side effects of its monetary accommodation, particularly degradation of market function, while maintaining an accommodative policy stance.

Timing coincided with retracement of yen depreciation, perhaps to avoid impression of bowing to outside pressure

The BOJ’s 20 December policy decision was a U-turn from its previous obstinate refusal to allow the 10y JGB yield to rise above 0.25% because doing so would purportedly be detrimental to the real economy. From last spring, the BOJ faced mounting criticism from companies and the public about its accommodative monetary policy fixated on attaining its 2% inflation target. The critics argued the BOJ should adjust its policies because they were fueling pernicious yen depreciation that was exacerbating inflationary pressures. BOJ Governor Kuroda strongly rejected such criticism, adamantly refusing to make policy adjustments to relieve downward pressure on the yen.

In December, however, just as criticism of BOJ policy subsided amid a pause in yen depreciation, the BOJ abruptly decided to adjust YCC as if acceding to the criticism. The move came as a huge surprise. I surmise the BOJ saw the December MPM as an opportune juncture to adjust YCC without conveying the impression of caving to outside pressure.

Kuroda may have acted early to give his successor more flexibility

Additionally, after steadfastly refusing to modify YCC, Kuroda may have decided to adopt a more flexible stance to facilitate a smoother policy transition for the benefit of his successor. If so, December’s policy adjustment could be construed as a step toward greater policy flexibility that otherwise would have occurred after Kuroda’s tenure ends in April. The adjustment was intended to also mitigate side effects. Because the move left the BOJ’s accommodative policy stance unchanged, even Kuroda was apparently willing to accept it, however grudgingly.

YCC adjustment is not precursor to imminent policy normalization

Since the BOJ adopted YCC in September 2016, it has made YCC more flexible by widening its 10y yield band multiple times. The BOJ did not begin to enforce the band’s ceiling as an inviolable 10y yield cap until spring 2022. This shift to a hard cap was presumably largely a reflection of Kuroda’s will. The latest YCC adjustment, by contrast, can be characterized as a reversion to the previous trend toward greater flexibility.

While December’s YCC adjustment can be construed as a head start toward post-Kuroda policy flexibility as already mentioned, it will not soon be followed by any major monetary policy changes or policy normalization. Before starting to normalize policy, the BOJ would have to recast its 2% inflation target as a medium/long-term target and conduct a comprehensive policy assessment. Given the heightened risk of yen appreciation in 2023 in response to economic deterioration, the post-Kuroda BOJ will likely adopt a cautious approach to policy normalization. I doubt the BOJ, after completing the requisite policy assessment, will exit its NIRP or otherwise start to normalize policy before mid-2024.

Major uncertainty surrounding revision of joint statement, including whether it will occur

Markets are rife with speculation that after Kuroda steps down in April, the January 2013 Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth will be revised through consultation between the government and Kuroda’s successor. While the Kishida Government may very well intend to revise the statement, much remains uncertain, including the content, timing and likelihood of any such revision.

The government may believe the BOJ’s fixation on attaining its 2% inflation target is to blame for the yen’s precipitous depreciation in 2022. It likely wants to take the initiative to persuade the BOJ to normalize policy or at least abandon such rigidity in favor of a more flexible policy stance or to help engineer a BOJ policy pivot.

The BOJ, however, is likely reluctant to revise the joint statement in 2023 for two reasons. First, if the statement is revised, the revision would spur financial market speculation that BOJ monetary policy changes would soon ensue. Such speculation could have adverse consequences like rapid yen appreciation. The BOJ may alert the government to such risks and propose waiting until at least 2024 to revise the joint statement, after the risk of economic deterioration and yen appreciation have receded and financial markets and the economy have regained stable footing. Once the statement has been revised, the BOJ would likely conduct a comprehensive policy assessment and then begin to normalize policy.

Second, while revision of the joint statement would have the benefit of increasing the likelihood of BOJ policy changes, it would also have the drawback of setting a precedent implying that the BOJ is required to consult with the government and gain its consent before making policy changes. Such a precedent would infringe upon BOJ independence. The January 2013 joint statement, drafted under strong government pressure, arguably has set a bad precedent already. The BOJ presumably does not want to compound one bad precedent with another.

Return to joint statement’s original intent

Rather than revising the joint statement, the BOJ would likely prefer to revise its inflation target at its own discretion before moving forward with policy normalization. By “revising its inflation target,” I mean lengthening the target’s timeline to medium/long term and loosening the linkage between the target and monetary policy, not lowering the 2% target. If the joint statement ends up being revised, its revisions would likely include these points.

Under the January 2013 joint statement, the 2% inflation target was not intended to be achieved through BOJ monetary policy alone. The statement was predicated on the government and private sector helping to achieve the target by boosting the Japanese economy’s growth potential and competitiveness. The BOJ could gain more monetary policy flexibility by explaining, and advocating a return to, this originally intended approach instead of revising the joint statement.

• Takahide Kiuchi

  Executive Economist