Features

Big news – even the Bank of Japan is starting to tighten monetary policy

The Bank of Japan has been keeping a very tight grip on monetary policy. Now, it’s taking things one step further. John Stepek explains what it means for your money.

180731-bank-of-japan
Bank of Japan governor Haruhiko Kuroda: will keep interest rates at current levels "for an extended period".

The Japanese government bond market has been the scene of some excitement in markets recently.

That's not a sentence I have to type very often.

We'll go into it in more detail below, but in a nutshell, investors don't believe that the Bank of Japan (BoJ) can stick to its promises. The BoJ begs to differ.

Who'll be the winner? And what does it mean for your money?

The thrills and spills of the Japanese government bond market

In September 2016, the Bank of Japan (BoJ) a serious monetary policy innovator decided to peg the yield on the ten-year Japanese government bond (JGB) at around 0%. In practice (so far), that means it won't let the JGB yield rise above 0.1% or so.

In other words, if the yield on the ten-year JGB rises to above 0.1%, then the BoJ prints money and buys as many bonds as it takes to get the yield back down. Alternatively, if the yield turns negative, the BoJ will sell bonds to get the yield back up.

This policy is known as "yield curve control". It's gone beyond quantitative easing (QE) to the next logical step, which is price-fixing, pure and simple.

This decision was taken at a time when all the pressure on bonds was still for yields to fall. The BoJ didn't want the yield on the ten-year to fall below 0%, because that would suggest that its war on deflation had been lost. Simply printing even more money would have risked the market shrugging its shoulders and saying "so what?"

It was a clever call. While most central banks were trying to figure out whether to extend or cut back on QE, the BoJ just cut straight to the heart of the matter. It said: "We'll do what's necessary to keep that yield at 0%. You can challenge that if you want, but we're the ones who have complete control over supply and demand."

Put like that, markets just went with it they had, after all, no other option.

Yet in the last week or so, that's changed. The BoJ has been challenged. Yields on the ten-year have risen (in other words, prices have fallen as investors have sold out). This has forced the central bank to intervene to drive them back down, on no less than three occasions.

To be clear, as Marcus Ashworth notes on Bloomberg, the BoJ has only had to threaten intervention four times since the policy was introduced. And it only actually had to buy bonds on one of those occasions.

However, it's now becoming clear that the pressure is on global yields to rise. Investors are starting to think that the BoJ's policy is unsustainable. The Japanese economy might not be seeing a lot of inflation but it is doing pretty well.

It's operating at full employment (in fact, employment is arguably even higher than that, in terms of what economists would have considered to be full employment).

As a result, there have been whispers that the BoJ was thinking of changing policy, to allow yields to rise further. One argument is that this would enable banks to improve their profitability (banks make money by borrowing over the short term to lend over the long term, so in effect, the bigger the gap between short-term bond yields and long-term ones, the more money they make).

So investors had started to take bets on a big shift at today's BoJ monetary policy meeting.

Turns out they were wrong.

Make no mistake the Bank of Japan has tightened policy (a little)

The BoJ shows no signs of backing down. Instead, it slightly widened the trading range of the ten-year yield it'll now be allowed to rise to 0.2% (or fall to -0.2%) before the BoJ intervenes.

BoJ boss Haruhiko Kuroda emphasised that this is a technical shift to enable the bond market to function properly, note Mark Williams and Marcel Theliant at Capital Economics. The BoJ made sure that everyone knows that it will keep interest rates at current levels "for an extended period". He also emphasised that improving bank profitability is not one of the BoJ's goals.

However, that said, a rise is a rise. In effect, the BoJ has gone from capping yields at 0.1% to capping them at 0.2%. I'm not sure that's easily dismissed. It's a tiny move but it is in effect, a very, very small hike in rates.

Sure, it's very tentative, and Kuroda, as the Capital Economics note makes clear, was at pains to emphasise that this isn't a step on the road to much tighter monetary policy particularly given the fact that inflation in Japan still remains stubbornly miles away from the 2% target.

But if we're wetting ourselves over 0.25% rises in the UK and the US, then a 0.1% rise in Japan is probably worth noting.

The market didn't seem entirely sure how to react. And given that the BoJ is still prepared to keep funnelling cheap money into the global financial system, this hardly kicks the legs out from under the market. And I'd certainly stick with Japanese equities.

But as with every other central bank these days, the focus is now on how monetary policy can get tighter without blowing things up. And as I said in yesterday's Money Morning, that's already having an effect on global housing markets. It'll be interesting to see what starts to struggle next.

Recommended

How long can the good times roll?
Economy

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
How Thailand became Asia’s toothless tiger
Emerging markets

How Thailand became Asia’s toothless tiger

Thailand was once an economic tiger that rocked world markets. Not any more, with tourism decimated but the pandemic and GDP set to shrink by around 7…
30 Oct 2020
Income-hunting: A focus on Asia
Sponsored

Income-hunting: A focus on Asia

SPONSORED CONTENT – Although coronavirus has had a huge global impact, Asia Pacific economies are exhibiting encouraging resilience
6 Oct 2020
Singapore's economy will bounce back
Asian economy

Singapore's economy will bounce back

Singapore has been battered by the collapse of global trade, and its main stockmarket index has lost a fifth this year. But analysts are feeling posit…
17 Jul 2020

Most Popular

The next 20 years: five new technologies on the horizon
Global Economy

The next 20 years: five new technologies on the horizon

What will everyday life be like in two decades’ time? Matthew Partridge peers into his crystal ball.
12 Nov 2020
This week’s rally in value stocks is just the beginning
Value investing

This week’s rally in value stocks is just the beginning

The arrival of a vaccine this week saw huge gains in the markets and investors switching out of big-tech growth stocks and into “value” stocks in more…
13 Nov 2020
Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
13 Nov 2020