Bank of Japan’s Loosening of Grip on Government Bonds Sends Ripples through Global Markets
Japan, known for holding the highest debt in the world, has made a significant move that has grabbed the attention of investors worldwide. On Friday, the Bank of Japan decided to ease its control on benchmark government bonds, signaling a potential shift in its commitment to cheap money.
Japan’s low interest rates have had far-reaching effects, with the potential to drive up rates globally. However, rising interest rates abroad and increased inflation have weakened the yen and prompted Japan to reevaluate its longstanding monetary policy.
By allowing yields on 10-year government bonds to exceed the current ceiling of 0.5 percent, the Bank of Japan has adopted a more flexible approach. This decision comes after months of speculation that the bank could tighten lending, following a decision last year to widen the trading range for 10-year bonds.
The previous change led to a speculative assault on the new yield target, forcing the Bank of Japan to intervene significantly. Analysts suggest that this experience likely influenced the bank’s new approach.
While the bank aims to gradually reduce bond purchases and allow rates to rise incrementally, it wants to avoid appearing to be tightening monetary policy. By offering to buy 10-year bonds at twice the previous rate, the bank hopes to allow bonds to trade at higher yields without causing panic in the market.
Japan’s ultra-easy monetary policy aims to achieve an inflation rate of 2 percent over time. However, inflation has exceeded this target for over a year, hitting 3.3 percent in June. The Bank of Japan expects inflation to reach around 2.5 percent in fiscal year 2023 but foresees a drop below the 2 percent target by 2025.
Controlling bond yields has been a crucial aspect of Japan’s monetary easing policies. The 10-year bond influences Japanese lending rates, which policymakers have kept low to stimulate economic growth.
However, the bank’s efforts to keep yields low have come at a high cost. To rein in the market, the Bank of Japan has spent a substantial amount of money purchasing its own bonds, equivalent to over 3 percent of the country’s GDP after the trading range was widened last year.
With other central banks, like the Federal Reserve, raising interest rates to combat inflation, the Bank of Japan has faced increasing pressure. Rising interest rates abroad have weakened the yen and exacerbated inflation in Japan, heavily reliant on exports.
Friday’s move by the Bank of Japan is expected to test its commitment to the new approach. Markets may exert further pressure, potentially leading to more loosening or even a complete abandonment of the policy.
Unwinding Japan’s easy money policy will be a challenging and lengthy process. Years of low rates mean that even small increases could have costly implications for households and businesses dependent on low-cost loans.