Bank of Japan Struggles to Keep Yields Low Amid Global Rate Hikes

The Bank of Japan (BoJ) is facing mounting challenges as it tries to maintain its ultra-loose monetary policy amid a weakening yen and rising global bond yields.

The BoJ has kept its short-term interest rate at -0.1% and its target for the 10-year government bond yield at around 0% since 2016, as part of its unprecedented stimulus program to boost inflation and growth.

However, the invasion of Ukraine by Russia, the COVID-19 pandemic and the hawkish outlook of the US Federal Reserve have moved against the BoJ’s stance and put pressure on the country’s currency.

The yen has fallen sharply against the dollar and other major currencies in recent months, reaching a 33-year low of 150.66 per dollar on Friday. A weaker yen makes imports more expensive and erodes the purchasing power of consumers and businesses, potentially undermining the BoJ’s inflation goal of 2%.

Meanwhile, the gap between Japanese and US bond yields has widened significantly, as the Fed has raised its main interest rate by 0.75 percentage points this year and signaled more hikes to come. The yield on the 10-year US Treasury note surged to a 16-year high of 3.25% on Friday, while the yield on the 10-year Japanese government bond (JGB) hovered around 0.9%.

The divergence in yields makes Japanese bonds less attractive for investors, who may seek higher returns elsewhere. This could trigger a sell-off in JGBs, forcing the BoJ to intervene more aggressively to keep its yield target.

The BoJ has already increased its bond purchases in recent weeks, buying a record 1.8 trillion yen ($12 billion) of JGBs on Thursday. The BoJ also said it would conduct an unscheduled operation on Friday to buy more bonds with maturities of five to 10 years.

Some analysts expect the BoJ to revise its yield curve control (YCC) policy, which allows the 10-year JGB yield to fluctuate within a range of plus or minus 0.25%, at its next meeting on Oct. 31. The BoJ may widen the band to give itself more flexibility and reduce market distortions.

However, others doubt that such a tweak would be enough to ease the pressure on the BoJ and the yen. They argue that the BoJ may have to consider more drastic measures, such as raising its interest rate or scaling back its bond purchases, to signal a shift in its policy stance.

“If the BoJ wants to see a stronger yen, I think they will need to do more than just widen the band yet again,” Rodrigo Catril, currency strategist at National Australia Bank in Sydney, said. “The market is right to be cautious.”

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