No country in the world holds as much debt as Japan, which has well over $1 trillion in U.S. government treasuries alone. Even the slightest shift to Japan’s low interest rates reverberates well beyond its borders, with the potential to drive up rates globally.
So, when the Bank of Japan on Friday slightly loosened its grip on a benchmark government bond, it was big news for world markets.
The move was the latest signal that the country may revise its longstanding commitment to cheap money, meant to spur Japan’s laggard economic growth, as rising interest rates abroad have driven up inflation and weakened the yen.
In an announcement following a two-day policy meeting, the bank said it would take a more flexible approach to controlling yields on 10-year government bonds, effectively allowing them to slip above the current ceiling of 0.5 percent.
The move was intended to “enhance the sustainability of monetary easing” by “nimbly responding to both upside and downside risks to Japan’s economic activity and prices,” it said.
The change comes after months of speculation that the bank could move to tighten lending.
The bank’s ultra easy monetary policy is aimed at attaining demand-driven, sustainable inflation of 2 percent, a level policymakers believe would lift both corporate profits and wages in a virtuous cycle.
Inflation in Japan, the world’s third largest economy, has exceeded that target for over a year, hitting 3.3 percent in June. But the bank’s governor, Kazuo Ueda has questioned whether the price increases — which have been largely attributed to supply-side issues — are sustainable, leading most analysts to expect that a policy tweak would not happen until later this year.
In a statement, the bank said that it anticipated inflation would reach around 3 percent in fiscal year 2023, an increase from its previous forecast of 1.8. It cited “cost increases led by the past rise in import prices” as the main factor in the change.
Controlling bond yields has been a central element of Japan’s monetary easing policies.
The 10-year bond plays a key role in setting Japanese lending rates, which policymakers have sought to keep at rock bottom as part of their efforts to stimulate economic growth by making money cheaper for borrowers.
The effort has come at a high cost: to keep yields down, the bank has had to spend enormous sums on purchasing its own bonds.
The Bank of Japan has come under increasing pressure over the last year as other central banks, led by the Federal Reserve, began raising rates in an effort to battle inflation stemming from the pandemic and Russia’s invasion of Ukraine.
Inflation in Japan never reached the levels seen in the United States and Europe. But rising interest rates abroad substantially weakened the yen, as money flowed out of the country in search of higher returns. That worsened inflation in Japan, which is highly dependent on exports for food and energy.
Nonetheless, the bank stood firm, resisting both domestic calls to intervene and assaults by speculators hoping to make a fortune betting against Japan’s ability to defend its yield target.
Friday’s move is likely to put more pressure on the bank as markets seek to test its commitment to the new trading band, potentially leading to further loosening or even a complete abandonment of the policy.
But unwinding Japan’s monetary easing measures will not be quick or easy. Years of low rates mean that even small interest rate increases could be costly for households and businesses, which have come to rely on easy access to low-cost loans.