Bank of Japan’s YCC policy backfires as pressure for interest rate hike grows

The Bank of Japan is being pressured to change its policy on interest rates. The pressure comes as part of an attempt by the central bank to buy more time backfired as December inflation hit 4%. Bond investors have been testing the central bank’s resolve, with a meeting set this week to discuss the distortions in the market.

Bank of Japan under pressure to change interest rate policy

Many global central banks have been aggressively hiking interest rates to address rising inflation. However, the BOJ has not taken a similar stance, and it has continued to battle against such hikes despite inflation rising higher than the bank’s estimates

Investors have been raising the bond yields for the Japanese government, which has tested the policy implemented by the BOJ regarding yield curve control. Last month, the central bank shocked the financial markets after raising the cap on its 10-year field from 0.25% to 0.5%.

Policymakers expected that the recent changes implemented in December would extend the lifespan of the attempts by the BOJ to control interest rates in line with the estimates until it could be determined whether the recent hike in wages would be felt across the country. Some changes are expected to be seen after the successor of Governor Haruhiko Kuroda takes over in April.

The policymakers anticipated that the BOJ could unwind the YCC in an orderly manner under the leadership of a new governor. A policy change would see the BOJ only raising rates when wages were increasing quickly to ensure that inflation remains within the bank’s target of 2%.

However, the tweaks introduced by the BOJ created a wide range of expectations that a significant change was on the way. On Friday, bond sellers surpassed the 0.5% yield cap. The situation forced the BOJ to engage in emergency bond buying to lower the interest rates. The BOJ has also announced plans to conduct additional bond-buying.

BOJ under pressure to adopt changes

The wage level in Japan remains low, and the result of the upcoming Tuesday-Wednesday meeting remains unclear. However, it is clear that the plans of the BOJ are not successful, and more market changes will be on the way.

However, commodity prices worldwide are dropping, triggering expectations that inflation will drop back to the target set by the BOJ. Investors are optimistic that a change will be seen this week, including the BOJ raising the 10-year target band cap to 0.75%. However, most of the changes that will be seen this week will depend on whether the BOJ sees the market distortions as severe enough to necessitate more action.