The Bank of Japan's Yen Weakness Break, the Market Did Not Believe It

Yield Curve Policy Revised but Market Expectations Not Met, Only Yen Depreciation Continues
Some Analysts See 'Gradual Tightening Operation'

The Bank of Japan (BOJ), Japan's central bank, revised its yield curve control (YCC) policy, which had been suppressing the 10-year government bond yield from exceeding 1% the previous day, but the yen appreciated against the dollar. Although the BOJ decided to tolerate a certain level of long-term bond yields rising above 1%, the yen's value fell as the move fell short of market expectations.

Kazuo Ueda, Governor of the Bank of Japan (BOJ)

On the 1st, in the New York foreign exchange market, the yen's value against the dollar fell to 151.70 yen around 1:45 a.m. The yen-dollar exchange rate surpassing 151 yen is the first time in about a year since October 21 of last year. As of 9 a.m. the same day in the Tokyo foreign exchange market, the yen-dollar exchange rate is currently at 151.32 yen. After re-entering the 150 yen range for the first time in five days the previous day, the downward trend has continued.

Since the announcement of the BOJ's monetary policy meeting results on the 31st of last month, the yen's value has shown a downward trend. The BOJ revised its YCC policy to operate more flexibly, stating it would tolerate a certain level of long-term bond yields exceeding the 1% ceiling. Previously, in July, the BOJ maintained the bond yield ceiling at 0.5% but indicated it would tolerate yield increases up to 1% depending on market movements.

Experts analyzed that although the BOJ set a tightening policy path, the market did not view it as tightening. Given that central banks worldwide have already embarked on massive interest rate hikes, it is difficult to consider the slight revision of YCC as a tightening measure.

Arindam Mitra, a macroeconomic investment strategist at BNY Mellon Asset Management in the United States, explained, "The BOJ's decision is unlikely to have a sufficient ripple effect to lead to a rise in the yen's value," adding, "For the yen to turn stronger, a pivot (monetary policy shift) in the U.S. may be necessary."

The BOJ's future inflation outlook also differed from market expectations. The BOJ raised its inflation forecast for this year and next year to 2.8% each, while lowering the 2025 inflation forecast to 1.7%, suggesting the possibility of future inflation deceleration. Governor Ueda also stated at a press conference following the policy announcement, "The situation where we can predict with sufficient accuracy whether inflation will continue to grow in the 2% range, which is the BOJ's target, has not yet arrived." The projection that the economy may slow down implies that the BOJ still needs time to exit its negative interest rate policy.

Major foreign media explained, "Some investors expected the BOJ to completely abolish the YCC policy since inflation exceeded the BOJ's target and the yen's value plummeted," and "They expected the BOJ to take decisive measures to narrow the interest rate gap between the U.S. and Japan, but it fell short of expectations."

Some analysts suggest that the BOJ conducted a mild tightening operation considering the neutral interest rate. The Nihon Keizai Shimbun diagnosed that the BOJ likely recognized the need to raise the neutral interest rate from the current level to steadily raise Japan's inflation and potential growth rate. The neutral interest rate refers to the level of interest rates that can maintain inflation while raising the potential growth rate without downward pressure. Nihon Keizai explained that the BOJ probably judged this appropriate level to be at least 1%. By not strictly enforcing the long-term yield ceiling at 1% and operating the YCC policy flexibly, the BOJ can reduce the burden of government bond purchases caused by exceeding the interest rate ceiling.

The Nihon Keizai Shimbun explained, "It will be difficult to avoid a rise in long-term interest rates above 1% during the process of moving toward an exit strategy," adding, "Since this level of interest rates is unavoidable to exit the easing policy, the BOJ revised the YCC early, citing the rise in U.S. Treasury yields as justification."