The monetary surprise last week came not from the ECB or the Federal Reserve, but from the Bank of Japan. In monetary terms, the Bank of Japan has gone further than the other two central banks in recent years. Where those two banks fixed the quantity (of bonds to be bought), the Bank of Japan (BoJ) fixed the price. So then, as a central bank, you are obliged to buy up everything on price. As long as a central bank has credibility, the market will usually do the job for you. But in December, the BoJ decided to raise the price ceiling from 0.25 per cent to 0.50 per cent. Since Kuroda, who shaped this policy, left in March, it was expected that the policy would be abolished soon. This has taken longer than expected. The Yield Curve Control (YCC) policy was unsustainable because it had become a pro-cyclical policy. Rising inflation (now higher in Japan than in the US) caused interest rates to rise, thus forcing the central bank to buy up bonds, according to YCC. This is of course strange, a central bank starting to stimulate at the same time as inflation is rising. We saw the opposite in 2020. At the start of the corona pandemic, interest rates fell sharply which would mean that the central bank had to sell bonds to keep interest rates just high. A tightening policy at the onset of a crisis is not so fortunate either.
Effectively, this policy stopped last week. Instead of 0.5 per cent, it will now be 1.0 per cent (above or below 0.5 per cent). The Bank of Japan pretended it was a technical adjustment, but of course, it is not. Moreover, the BoJ built in so much flexibility that it was almost an invitation to the market to test the BoJ. There are at least two reasons for adjusting the policy. First, inflation continues to rise. In addition, the yen has continued to weaken over the course of this year. The fair value for 10-year interest rates in Japan is 1 to 1.5 per cent, and this adjustment puts that within reach.
The somewhat longer-term implications are likely to be large. Japan is a major financier of the rest of the world. In Japan, it is common for women to take care of finances. The archetypal Ms Watanabe looks like a professional trader who borrows money in yen on a PC or nowadays usually mobile and expends it in high-yielding currencies. With a constantly weakening yen, that was a win-win story for a long time, a licence to print money. Rising interest rates in Japan are increasing the cost of borrowing, with the result that many foreign assets will be repatriated in the near future. That makes for a stronger yen, making these carry trades risky. Recall that Japan is often the main financier of government bonds, for example. It is likely that the yen (and thus other Asian currencies) will gain strength, at the expense of the US dollar.
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