After the Bank of Japan made an unexpected adjustment to its yield curve control program, the yen depreciated. Last month, the Bank of Japan announced that it would "flexibly" control the 10-year yield, allowing it to fluctuate around 0.5% and buying government bonds at 1% every business day, effectively creating a higher upper limit.
Governor Kazuo Ueda's rare acknowledgment of currency issues being considered in policy decisions surprised many observers at a post-policy meeting press conference. He stated that foreign exchange volatility was one of the factors prompting the Bank of Japan to let 10-year bond yields rise above 0.5%.
Analysts noted that this position seemed contradictory to the central bank's previous emphasis on currency policy falling under the finance ministry's jurisdiction. Usually, the Bank of Japan only concerns itself with the impact of yen movements on the economy and inflation.
The question now is whether the Bank of Japan's policy decisions will be more influenced by currency volatility. Despite Ueda's warning, the Japanese currency fell to as low as 143.89 per dollar last week, driven by rising US treasury yields after Fitch Ratings downgraded the US credit rating.
Chief market economist Daisuke Karakama of Mizuho Bank in Tokyo said, "I think many people took his remarks as a warning against the weak yen." "But by citing the currency as a factor, Ueda may be increasing the probability that the market will go on an offensive toward a weaker yen. The market may test how much weakness in the yen the BOJ will tolerate."
At the press conference, Ueda cited currency volatility as one of the reasons for the YCC program's revision. After reiterating the standard assurance that the BOJ doesn't target exchange rates, Ueda added, "Within the context of YCC's side effects and our need to quell financial market volatility, currency volatility was taken into consideration in today's move."
Although these comments could serve as a warning to market participants, they could also fuel speculation of further policy changes if the yen continues to weaken.
According to Naka Matsuzawa, chief strategist at Nomura Securities Co., Ueda's forward-looking and risk-management approach is similar to norms set by other central banks. However, the reference to foreign exchange volatility as a factor behind the YCC change was unusual. He also said, "It's undeniable now that expectations for policy change and a weak yen are more closely linked." "It would be wise for the BOJ to put out this potential fire before further yen weakness spurs rate hike expectations."
While the currency market is still digesting the implications of the Bank of Japan's somewhat complex policy, the direction of the yen hinges on how the Bank of Japan operates its bond market operation and where yields will settle. So far, the central bank has intervened in the market twice last week to limit the increase in yields. Mizuho Research's Miyazaki said the Bank of Japan can only allow 10-year yields to rise to around 0.7% to narrow rate differentials. Politicians and government officials won't tolerate any moves higher than that, as it would increase the cost of fiscal spending too much.
In Japan, the finance ministry is in charge of foreign exchange rates, and any currency intervention is decided by the finance minister. The Bank of Japan carries out the action on behalf of the ministry. After last autumn's highly-watched interventions to support the yen, significant weakening is likely to spur more speculation over more action from authorities.
Governor Kazuo Ueda's rare acknowledgment of currency issues being considered in policy decisions surprised many observers at a post-policy meeting press conference. He stated that foreign exchange volatility was one of the factors prompting the Bank of Japan to let 10-year bond yields rise above 0.5%.
Analysts noted that this position seemed contradictory to the central bank's previous emphasis on currency policy falling under the finance ministry's jurisdiction. Usually, the Bank of Japan only concerns itself with the impact of yen movements on the economy and inflation.
The question now is whether the Bank of Japan's policy decisions will be more influenced by currency volatility. Despite Ueda's warning, the Japanese currency fell to as low as 143.89 per dollar last week, driven by rising US treasury yields after Fitch Ratings downgraded the US credit rating.
Chief market economist Daisuke Karakama of Mizuho Bank in Tokyo said, "I think many people took his remarks as a warning against the weak yen." "But by citing the currency as a factor, Ueda may be increasing the probability that the market will go on an offensive toward a weaker yen. The market may test how much weakness in the yen the BOJ will tolerate."
At the press conference, Ueda cited currency volatility as one of the reasons for the YCC program's revision. After reiterating the standard assurance that the BOJ doesn't target exchange rates, Ueda added, "Within the context of YCC's side effects and our need to quell financial market volatility, currency volatility was taken into consideration in today's move."
Although these comments could serve as a warning to market participants, they could also fuel speculation of further policy changes if the yen continues to weaken.
According to Naka Matsuzawa, chief strategist at Nomura Securities Co., Ueda's forward-looking and risk-management approach is similar to norms set by other central banks. However, the reference to foreign exchange volatility as a factor behind the YCC change was unusual. He also said, "It's undeniable now that expectations for policy change and a weak yen are more closely linked." "It would be wise for the BOJ to put out this potential fire before further yen weakness spurs rate hike expectations."
While the currency market is still digesting the implications of the Bank of Japan's somewhat complex policy, the direction of the yen hinges on how the Bank of Japan operates its bond market operation and where yields will settle. So far, the central bank has intervened in the market twice last week to limit the increase in yields. Mizuho Research's Miyazaki said the Bank of Japan can only allow 10-year yields to rise to around 0.7% to narrow rate differentials. Politicians and government officials won't tolerate any moves higher than that, as it would increase the cost of fiscal spending too much.
In Japan, the finance ministry is in charge of foreign exchange rates, and any currency intervention is decided by the finance minister. The Bank of Japan carries out the action on behalf of the ministry. After last autumn's highly-watched interventions to support the yen, significant weakening is likely to spur more speculation over more action from authorities.