Bank of Japan gets serious on yield- curve control but difficulties may lie ahead

The Bank of Japan has put its “yield- curve control” plan into practice. On Thursday the central bank offered to buy shorter- dated bonds in unlimited amounts, the first time it has wielded the tools it introduced two months ago. This episode hasn’t cost the BOJ anything, because the bank offered below- market prices that nobody took up. Even so, it shows how the revamped framework aims to shield Japan from rising global yields.

The BOJ’s new regime wants the 10- year bond yield to stay around zero, supporting an existing super- easy policy of “quantitative and qualitative easing”, as Governor Haruhiko Kuroda seeks to generate sustainable, healthy inflation. So the BOJ will still keep shortterm interest rates very low or negative, and buy about 80 trillion yen ($ 723 billion) of bonds a year.

However, Donald Trump’s US election victory stoked expectations of a loosening of public purse strings, leading to generally higher growth and inflation. That sparked a sell- off in Treasuries, dragging down prices and lifting yields for Japanese Government Bonds ( JGB). This presents an early test of the BOJ’s strategy overhaul.

Thursday’s use of unlimited, fixed- rate purchases set a ceiling on shorter- dated yields. The BOJ offered to buy current 2- and 5- year bonds at 9 and 4 basis points below zero respectively. No bonds changed hands. But if Treasuries continue to rise, investors are likely to test the BOJ’s appetite more thoroughly. If benchmark US yields, already above 2.3 percent, keep rising, the BOJ may have to buy whatever the market throws at it if it wants to keep JGB yields steady.

In theory the bank could see its already huge balance sheet swell uncontrollably – although given so many bonds are already in the BOJ’s vaults or held by institutions who cannot sell, it is an open question how much trading would actu- ally occur. The commitment to free 10- year money could also let Shinzo Abe’s government borrow and spend more freely, despite Japan’s already high debt level.