Across the developed markets, central banks have embarked on a tightening path—with one exception: the Bank of Japan (BOJ). Will Japan’s central bank soon follow suit? To answer this question, we need to first review the hands that Japanese policymakers have already played.
The Path to Negative Rates and Yield-Curve Control
In the ten years since then Prime Minister Shinzo Abe introduced his “three arrows”—monetary policy easing, fiscal policy support and structural reform—for ensuring Japan’s economic recovery, Japan has struggled to find the right balance for achieving its goals.
First, in 2013, the BOJ raised its inflation target from 1% to 2% to tackle chronic deflation—but this target proved tough to achieve.
So, in January 2016, in a renewed attack on chronic deflation, the BOJ adopted a negative interest-rate policy (NIRP) by cutting its policy rate to ¬–0.10% and massively increasing the money supply by buying long-term Japanese government bonds (JGB). The market reacted badly. The yield curve flattened, bank stocks fell sharply, and the Japanese yen strengthened—the opposite of the intended effect.
Consequently, in September of the same year, the BOJ added a new tool: yield-curve control (YCC), with a target of zero percent for the 10-year JGB yield and a commitment to ongoing expansion of the monetary base. YCC achieved its intended effects, steepening the yield curve (Display) and boosting inflation expectations. Bank stocks recovered and the yen weakened (thanks in part to a strengthening US dollar).
Today, six years later, NIRP and YCC remain in place. But recently, some quirks in the Japanese yield curve have indicated that investors expect the BOJ to start to unwind these policies. For example, immediately prior to the BOJ’s June 16–17 meeting, dislocations appeared in the yield curve near bonds targeted by the BOJ for purchase in unlimited quantities at a yield of 0.25% (Display).