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Investment banks warn investors of potential BoJ surprise

Investors are widely expecting the Bank of Japan to buck the global trend and keep monetary policy on hold on Friday, but a clutch of heavy-hitting investment banks is warning them to brace for a shock.

Most major central banks are coming towards the end of the historically rapid tightening cycles they unleashed in an effort to hose down inflation that erupted in the wake of Covid lockdowns, but the BoJ has largely held firm, happy to see Japan’s relatively tame inflation pick up after decades in the freezer.

In a Bloomberg survey of 50 economists this month, 42 expected the central bank to opt for no change, maintaining its seven-year policy of buying bonds to depress yields, known as yield curve control, in an effort to ensure modest inflation sticks.

But previous adjustments to this policy have generated large shifts in markets in Japan and across the world, and some banks say it is wise to be ready this time around.

UBS economist Masamichi Adachi said he expected the BoJ to tweak the yield curve control policy, adding that “the majority may have misinterpreted” recent comments from BoJ governor Kazuo Ueda in which he signalled patience in achieving 2 per cent inflation.

If there was a change in the policy, markets should expect a push higher in Japanese government bond yields, a jump in the yen and a dent in the country’s stocks, which had outperformed much of the rest of the world so far this year, the Swiss bank said.

Goldman Sachs, JPMorgan, Nomura, BNP Paribas and Morgan Stanley MUFG have also argued the BoJ will relax its grip on the bond market. SMBC Nikko has even said there is a 50 per cent chance that the BoJ will abandon yield curve control altogether this week.

The future of Japan’s ultra-loose monetary policy has been closely watched as inflation in Asia’s most advanced economy has continued to rise even as the rate of consumer price increases has started to fall in the US and Europe. Headline inflation in Japan rose to 3.3 per cent in June, outpacing the US figure for the first time in eight years.

In the US, the Federal Reserve has ended new bond purchases and pushed its key rate up 5 percentage points since March 2022. It is likely to bump up rates once more, by 0.25 percentage points, this week, and then pause.

The European Central Bank has lifted rates from minus 0.5 per cent in July 2022 to 3.5 per cent. It is also expected to increase them again this week and apply the brakes soon after. But the BoJ’s base rate remains at minus 0.1 per cent, and it holds 10-year yields at zero per cent, tolerating just half a percentage point of movement on either side of that target.

Officials have led most investors to believe this will stay in place. In addition to Ueda, BoJ board member Seiji Adachi suggested last month that smoother market functioning since the last yield control tweak in December meant it was appropriate to keep the framework in place.

But UBS’s Adachi said the central bank could argue that underlying inflation had strengthened, justifying a policy tweak to improve the functioning of the bond market. The BoJ can then still keep its other easing measures, such as negative interest rates, until it is more confident of sustainably achieving its 2 per cent inflation target.

“If the BoJ doesn’t move, we think it is unwise but it would underscore that its outlook on inflation is extremely cautious,” he said. Economists expect the BoJ to raise its core inflation forecast for the 2023 fiscal year from 1.8 per cent to more than 2.5 per cent.

The BoJ last altered its yield curve control policy last December, widening the tolerance to half a percentage point from a quarter — a move that shocked economists and sent government bonds sliding in price.

Now some banks think the BoJ will widen the band to a full percentage point on either side of zero.

Mark Dowding, chief investment officer at BlueBay Asset Management, was one of the few investors who had anticipated December’s shift. He believes the BoJ will raise the top band of its yield curve control policy between 0.75 and 1 percentage points this week, to coincide with what he expects will be a rise in BoJ inflation forecasts. 

Reflecting that view, he said he had been betting against Japanese government bonds and betting on the “undervalued” yen since March. “Ueda has been playing down speculation of change in policy because he does not want the speculators to profit,” he said. If the BoJ did change its stance, the yen would rise to at least ¥135 per dollar, he added.

The yen is pinned at about ¥141.2 against the dollar, close to its weakest level in two decades, reflecting the yawning gap in monetary policy stances in the two economies. The Japanese currency has picked up from its lows late last year, suggesting investors have sniffed some possibility that the BoJ could change tack, but despite the rally the yen remains notably weak against the dollar.

Similarly, Japanese government bonds have weakened somewhat, but with 10-year yields at 0.46 per cent, the market is not staging a serious challenge to the BoJ’s current stance.

If the BoJ delayed changing its yield curve control policy, Takeshi Yamaguchi, chief Japan economist at Morgan Stanley MUFG, warned there was a higher risk of a disorderly exit since the market will start to factor in the start of a rate hike cycle.

“If the BoJ waits until its 2 per cent target is achieved, it will be way behind the curve,” he said.

Rayna Prime

Rayna Prime

Rayna Prime Editor