And then there was the Bank of Japan.
After last week’s series of central bank meetings, culminating in the Federal Reserve’s surprise turn to looser policy next year, the BOJ will be watched early on Tuesday to see if there is any sign it is ready to to abandon long-standing policies of negative interest rates and yield curve control. , an extraordinary program that has put a severe brake on how high long-term Japanese bond yields can rise.
Economists see virtually no chance that the BOJ will raise rates when it ends its two-day policy meeting. But investors are wary of any sign that the world is about to lose its last remaining anchor to the extraordinary, ultra-loose monetary policy settings that dominated the global financial system after the global financial crisis and during the COVID-19 pandemic.
Bank of America economists Izumi Devalier, Shusuke Yamada and Tomonobu Yamashita said in a note late last week that if, as they expect, the BOJ plans to end its negative interest rate policy early next year, it will do so. will likely give a signal after Tuesday’s meeting, either through the policy statement or BOJ Governor Kazuo Ueda’s post-meeting press conference.
If the signal comes in the statement, it could take the form of new language recognizing further progress toward the bank’s 2% price stability target, and a directive from Ueda directing staff to consider options to guide short-term interest rates into positive territory.
Under a “weaker form of guidance,” Ueda would use his press conference to say that policymakers believed they were getting closer to sustainable and stable inflation of 2% and were preparing to exit the NIRP, the economists wrote .
The Bank of Japan in October effectively abandoned its policy of keeping the yield on the 10-year Japanese government bond BX:TMBMKJP-10Y below 1%, saying the threshold would now serve as a “reference point.”
The BOJ sent shockwaves through global markets in July when it relaxed the limit, raising it from 0.5% to 1%.
The BOJ had introduced yield-curve control (YCC) in 2016, a policy aimed at keeping government bond yields low while ensuring an upward-sloping yield curve. Under YCC, the BOJ buys the number of JGBs necessary to ensure that the 10-year yield remains below the cap.
YCC was one of several extraordinary measures taken by the Bank of Japan in recent decades in an effort to combat deflationary prices. Inflation rose in the wake of Covid.
Changes in the YCC have caused or amplified the sell-off in U.S. Treasuries and other government bonds, increasing the volatility of stocks and other assets. That’s because the prospect of higher interest rates in Japan could prompt the country’s investors to repatriate money parked in foreign assets.
Meanwhile, Japan’s enforcement of an ultra-loose monetary policy has contributed to a decline in the Japanese yen, which fell to a more than 40-year low against the US dollar USDJPY last year.
and retested those levels last month.
The prospect of tighter BoJ policy and expectations that the Fed and other major central banks are done raising rates and will likely cut them in the coming months have led to a rally in the yen.
The dollar has fallen 3.6% against the Japanese currency so far in December, but remains up 9% this year.
Some analysts fear that the yen’s recovery has gone too far, too fast.
“The market’s position on the yen could not be clearer. Currently, the long Japanese yen is the most obvious trade in the currency markets. It’s almost too easy,” said Ipek Ozkardeskaya, senior analyst at Swissquote Banddank, in a Monday note.
“An aggressive signal from the BOJ has the potential to push the USDJPY below the 140 level even under the prevailing oversold conditions. Conversely, if the BOJ were to disappoint the market again, any price increases could attract the attention of top sellers,” she wrote.
Skeptics argue that the BOJ is unlikely to signal major changes. They argue that the post-COVID-19 inflation spike, amplified by a sharp increase in energy prices that pushed inflation to 4.4% in January, continues to decline.
Japan’s deflation problems are primarily the result of the aging and shrinking population, said Carl Weinberg, chief economist at High Frequency Economics, in a client note.
“Since most people who die of old age are retired, potential GDP is not affected by their loss. The slack is therefore persistent and increasing. Deflation is the natural companion of Japanese depopulation,” Weinberg said.
“We expect the CPI to fall again next year,” he said.
Inflation in Tokyo, a closely watched leading indicator of price developments, fell to an annual rate of 2.6% in November from 3.2% in October as food and energy inflation cooled.
The economy, meanwhile, contracted in the third quarter – down 2.9% year-on-year – and shows no sign of recovery this quarter, Weinberg said. He argued that even if Ueda thinks negative interest rates do not support prices and can be normalized, the timing would be wrong if the economy starts to contract.
“We expect no change in policy or guidance at this week’s BOJ Board meeting,” he wrote, adding inaction would likely trigger a reversal in the yen after the recent rally.