[News Terms] 'Solo Quantitative Easing'... What Is Japan's Core Monetary Policy YCC?

Haruhiko Kuroda, Governor of the Bank of Japan (BOJ).

[Asia Economy Reporter Lee Ji-eun] Since the Bank of Japan (BOJ), Japan's central bank, announced last month its plan to widen the allowable fluctuation range of long-term interest rates, turmoil has erupted in the Japanese financial market. The BOJ has been implementing the so-called YCC (Yield Curve Control) policy since September 2016, which controls long-term interest rates to remain within a certain range, and the market is now paying close attention to how long this policy can be sustained.

After concluding a two-day monetary policy meeting starting on the 17th, the BOJ announced on the 18th that it would maintain its accommodative monetary policy. Accordingly, the short-term interest rate was kept steady at -0.1%, and the allowable fluctuation range for the 10-year government bond yield, a benchmark for long-term interest rates, remains at ±0.5%.

The BOJ is conducting a policy of unlimited purchases of government bonds to keep the 10-year government bond yield moving within the predetermined interest rate range (±0.5%), a measure referred to as the YCC policy.

The BOJ introduced the YCC policy in 2016 when it implemented a negative interest rate policy of -0.1% on short-term rates, which caused government bond yields to fall excessively and led to a pronounced flattening of the yield curve. The yield curve is a graph showing the relationship between the remaining maturity period of bonds and their yields; a flattening of this curve means the interest rate gap between short-term and long-term government bonds is narrowing. Generally, bonds with longer maturities should have higher yields than those with shorter maturities. Therefore, a flattening yield curve is often interpreted as a sign of an impending recession.

When long-term government bond yields fall excessively, financial institutions that create products based on these yields and companies issuing corporate bonds face difficulties in raising funds. To directly control the interest rate spread between short- and long-term rates, the BOJ takes action to purchase government bonds when the 10-year bond yield rises.

The problem is that as the BOJ has been buying large amounts of government bonds to defend interest rates, its government bond holdings have surged sharply. As of the end of June last year, the BOJ's government bond holding ratio is estimated to have exceeded 50%. Moreover, after some adjustments to Japan's monetary policy last month, the 10-year bond yield surpassed the long-term allowable fluctuation range of 0.5%, prompting the BOJ to conduct another large-scale government bond purchase. In January alone, the BOJ spent a total of 17 trillion yen (approximately 163.9633 trillion won) on bond purchases, surpassing the 16.2038 trillion yen spent in June.

As the government bond holding ratio increases, the fiscal burden the BOJ must bear is also growing. According to Japan's Ministry of Finance, even assuming the current ultra-low interest rate environment continues, the Japanese government will have to pay 8 trillion yen (about 77 trillion won) annually in government bond interest over the next 10 years.

Experts are expressing doubts about the sustainability of the YCC policy. Harumi Taguchi, Chief Economist at S&P Global Market Intelligence, told Bloomberg, "The yield curve did not move as the BOJ wanted, but if the BOJ takes further action, it may appear as if it is responding to market pressure, making yield curve control even more difficult." Mari Iwashita, Chief Economist at Daiwa Securities, pointed out, "Even if the allowable fluctuation range for long-term interest rates is widened, it will not correct the interest rate distortion."