The incoming Bank of Japan (BoJ) Governor Kazuo Ueda’s comments on his policy intentions have been carefully worded throughout the recent parliamentary hearings.
However, Ueda acknowledged that some “surprise” policy shifts are necessary to avoid persistent speculation.
The window for action is narrow as the economic data will shift meaningfully over the next 6 months, with inflation pressures likely to fade rapidly.
Our baseline expectation is that the BoJ tweaks the parameters of yield curve control (YCC) by the July meeting. One option is to widen the tolerance band around 10-year JGB yields to at least +/-75bps.
Communication of the new policy stance is key. Any change must be accompanied by a clear statement of next steps and associated waymarks to help manage investor expectations.
Targeting the yield level of shorter maturity bonds – perhaps the 5-year sector – is also a possibility, as the BoJ may find it has more control over shorter maturity bonds.
A successful policy change would help re-anchor yields at a credible new level and improve market functioning.
However, there is a strong risk of the new peg also lacking credibility and facing sustained speculative attack.
Our baseline expectation is that the BoJ will adjust the parameters of its yield curve control framework by July. Widening the tolerance band around the 10-year JGB yields to at least +/- 75bps is one option. But there is the risk that speculators will attack the new peg, forcing the BoJ into a de facto crawling yield peg.