Bank of Japan Breakdown
As many of you will know, the Bank of Japan raised interest rates (+0.1%) for the first time since 2007, taking rates in the country to 0-0.1% from -0.1% previously.
What the BOJ is doing
- Ending negative interest rates
- Ending strict yield curve control
- Stopping buying ETFs and Japanese real estate investment trusts (J-REITS)
- Planning to stop buying corporate debt and commercial paper in around 1 year
What it is not doing
- Stopping buying government bonds (QE) – they will continue to purchase JGBs at the same pace and still respond to a ‘rapid rise’ in long term interest rates by purchasing more JGBs.
Source: BOJ
Source: BOJ
A bit of context
The Bank of Japan has run ultra loose monetary policy for decades now with negative interest rates put in place from 2016.
The Bank of Japan initially brought about unconventional monetary policy in order to combat persistent deflationary pressures, encourage spending and stimulate economic growth.
However, the BOJ have now become comfortable that they are approaching their 2% inflation target sustainably and they are able to take a step towards normalisation of policy.
Recent wage growth data appears to have been the final nail in the coffin for negative interest rate policy in the country as unions in the country secured the biggest wage increase in 33 years.
‘The Bank considers that the policy framework of Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control and the negative interest rate policy to date have fulfilled their roles’
Ultra loose policy has taken the form of the Bank of Japan running negative nominal interest rates (-0.1%), purchasing Japanese ETFs, REITs, corporate debt as well as enacting yield curve control.
What is yield curve control?
While the short term interest rates are more easily dictated by the Bank of Japan setting rates, further out the curve tenors are more subject to market forces. In order to keep borrowing costs in a range that the Bank of Japan has felt comfortable with they resorted to buying vast swathes of Japanese Government Bonds in order to keep yields down and decrease borrowing costs in the country.
While the current governor, Ueda, has tweaked how this is done in recent months the basic premise was that the BOJ would set an upper limit for the yield of the 10 year JGB, initially set at 0% in 2016 but relaxed to 1% by October 2024 after a few recent tweaks.
When this upper limit was threatened the BOJ would step in and JGBs, suppressing yields and resulting in the upper limit being maintained and stopping borrowing costs from rising out of the BOJ’s comfort zone.
As a result of the BOJ’s prolific buying of government debt they now own over 50% of total outstanding supply of JGBs, which is staggering.
ETFs?
The Bank of Japan started buying ETFs in 2010 and has since become the biggest holder of Japanese stocks, a step which the Bank has also gone back on at the meeting. With the Nikkei around all-time highs it was probably pretty difficult to justify a country’s central bank continuing to prop up stock prices.
Why care?
Japan has very deep pockets, they are the biggest holders of US Treasurys outside of the United States.
The fact that Japanese Government Bond yields have been so low while yields abroad are higher has resulted in Japanese investors looking elsewhere for yield and as such they have become big players in bond markets around the globe.
The first move away from Japan’s ultra loose monetary policy may signal a change in the tide to a world where more attractive yield can be found within Japan; this, in theory, might pull back on Japanese foreign bond investment and leaves some uncertainty around future flows out of the country into foreign markets.
Furthermore, markets will be looking to see if the BOJ moving away from their ultra loose policy will have an effect on the Yen carry trade. The carry trade is essentially the process of borrowing in Japanese Yen, using low interest rates, to then purchase higher yielding assets in other countries. This is widely used by financial institutions to take advantage of rate differentials (the difference in interest rates between countries).
However, it is important to remember that The Bank of Japan have not by any means committed to any rapid or substantial hiking cycle like those seen in Europe and the US and it looks like monetary policy in the country will remain accomodative in the near future:
‘Bank anticipates that accommodative financial conditions will be maintained for the time being.’