Despite some slightly better news coming from the economy, recent Bank of Japan commentary suggests that policymakers are in no rush to make any changes to its stimulus package. After the move to negative interest rates just over a year ago raised a chorus of questions concerning the longevity of the BoJ’s ultra-loose policy, the switch to yield curve control has been relatively successful in isolating Japan from the post-Trump rise in global yields.
With that in mind, we ask: what could make the Bank of Japan change direction?
Well there’s really two angles here, and the first starts with the Yen. Whether intentionally or not, the Bank of Japan’s control of long-term bond yields has been a major driver of recent currency moves (Figure 14). Should we get another significant move higher in global (especially US) yields, then the Yen would weaken further. That might start to raise concerns about living costs (mainly food); recall in the earlier stages of QE, officials became worried about falling real incomes as USD/JPY flirted with 125.
As a rough rule of thumb, US yields would need to increase above 2.7-2.8% for JPY to get closer to those levels. But even then, we think the BoJ would still be cautious about lifting its target for long-term rates.
The second, and more pressing, issue is the ever-dwindling availability of government bonds for the BoJ to buy. At the end of 2016, the Bank held just shy of 40% of total Japanese government bonds. As the BoJ seeks to control yields, the quantity of purchases should be more variable. But despite the shift to YCC, the Bank still commits to increase government bond holdings by “around ¥80 trillion” pa.
That’s created a slight headache for the BoJ when it releases its purchase plan each month. In February for example, it slightly reduced bond buying plans, prompting yields to spike. Given that the BoJ is keen to avoid looking like it is tapering purchases other than for purely technical reasons, we’d expect the BoJ to relax their current quantity targets over coming months. There have been some suggestions that the BoJ could at some point switch to a wide monthly purchase target range to offer more flexibility.